Flow-through entity

A flow-through entity (FTE) is a legal entity where income "flows through" to investors or owners; that is, the income of the entity is treated as the income of the investors or owners. Flow-through entities are also known as pass-through entities or fiscally-transparent entities.

Common types of FTEs are general partnerships, limited partnerships and limited liability partnerships. In the United States, additional types of FTE include S corporations, income trusts and limited liability companies.

Most countries require an FTE (or its owners) to file an annual return reporting the shares of income allocated to owners, and to provide each owner with a statement of allocated income to enable owners to report their shares of income on their own tax returns. In the United States, the statement of allocated income is known as a K-1 (or Schedule K-1).

Depending on the local tax regulations, this structure can avoid dividend tax and double taxation because only owners or investors are taxed on the revenue. Technically, for tax purposes, flow-through entities are considered "non-entities" because they are not taxed; rather, taxation "flows-through" to another tax return.

Definitions

According to International Bureau of Fiscal Documentation (IBFD) a pass-through entity or flow-through entity (FTE) is a "non-taxable entity, such as a partnership, under which the income or expense is generally regarded as income or expense of the participants under the transparency principle."[1] FTEs are based on conduit theory or pipeline theory which is defined as a "method of integrating the taxation at the entity and participator level under which income or deductions flow through from the entity to its participators. The entity is in effect regarded as an extension of the participators. A partnership is generally taxed according to the conduit system. The conduit system may be contrasted with the classical system."[1]

Types

In the United States, pass-through entities include "sole proprietorships, partnerships and S corporations that ... pay taxes at the individual rate of their owners"[2] as well as income trusts and limited liability companies.

According to CNN Money, in the United States, most "businesses are set up as pass-throughs, not corporations"[3] which "means their profits are passed through to the owners, shareholders and partners, who pay tax on them on their personal returns under ordinary income tax rates."[4] In other words pass-through businesses are not "taxed like corporations and instead pay taxes on business income as if it were personal income."[4]

Chronology

According to a report published by Brookings in May 2017, in the early 1980s almost all business income in the United States was generated by C corporations. In terms of Income tax in the United States C corporations are taxed separately from their owners.

In December 2004 the Financial Asset Securitization Investment (FASIT) which was a flow-through entity formed in the United States, was repealed. FASIT was an investment instrument in "non-mortgage receivable pools such as credit card receivables, automobile loans, construction loans, and finance leases." FASITS in existence on October 24, 2004 were exempted from the repeal.[1]

By 2005 the US Internal Revenue Service viewed Son of Boss as "an abusive transaction aggressively marketed in the late 1990s and 2000 primarily to wealthy individuals." The IRS began a "settlement initiative" which "required taxpayers to concede 100 percent of the claimed tax losses and pay a penalty of either 10 percent or 20 percent unless they previously disclosed the transactions to the IRS."[8]

By 2013, "only 44 percent of the income of business owners was earned through C-corporations."

Starting in 2013, Kansas Governor Sam Brownback undertook what was described by The Atlantic in a June 2017 article as the United States' "most aggressive experiment in conservative economic policy".

See also

• Sole proprietorship