Flow-through entity

From Wikipedia, the free encyclopedia

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.


According to International Bureau of Fiscal Documentation [fr] (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]: 313  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]: 89 


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]

Sole proprietorships[edit]

A sole proprietor is "someone who owns an unincorporated business by himself or herself." However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation.[5] In the United States, sole proprietors "must report all business income or losses on [their] personal income tax return; the business itself is not taxed separately. The IRS refers to this as "pass-through" taxation, because business profits pass through the business to be taxed on your personal tax return.[6]

S corporation[edit]

S corporation shareholders are subject to tax on their "pro rata shares of income" based on their shareholdings in the S corporation which is not itself taxed.[7]

Bond and bond option sales strategy (BOSS)[edit]

FTEs included in the 2009 IBFD International Tax Glossary included the Bond and Bond Option Sales Strategy (BOSS) transaction] referring to an "investment strategy developed in the United States to generate tax losses without a corresponding economic loss. The transaction involves the use of a partnership or other flow-through entity that makes an investment in a foreign corporation that is capitalized for the purpose of carrying out the transaction. Variants of Boss Transactions are referred to as Son of Boss Transactions.[1]: 45 


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.[8]

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]: 179 

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."[9]

By 2013, "only 44 percent of the income of business owners was earned through C-corporations."[8]

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".[10] From 2013 to 2017, 300,000 businesses as pass-through income entities, benefited from the complete tax exemption. [T]ens of thousands of Kansans were able to "claim their wages and salaries as income from a business rather than from employment."[11] Brownback's tax overhaul created pass-through income tax exemptions as well as trimming income tax, eliminating some corporate taxes.[10] From 2013 to 2017, Kansas experienced budget shortfalls culminating in a $350 million budget shortfall in February 2017, which "threatened the viability of [the state's] schools and infrastructure".[10] In response, in June 2017, the extreme tax cuts were rolled back to 2013 levels.[10]

By 2017, pass-through businesses earned the "majority of business income" in the United States and "owners of S-corporations and partnerships now earn about half of all income from businesses."[8]

According to a September 2017 article in The New York Times, about "95 percent of companies in the United States are structured as pass-through entities, generating the bulk of the government’s tax revenues."[12]

On December 2, 2017 the U.S. Senate passed a tax overhaul bill as part of the proposed Tax Cuts and Jobs Act of 2017 that reduced taxes on pass-through business income by allowing them to "deduct 23% of their income".[3] The Senate added features to the bill to prevent abuse.[3] In a November article, The New York Times reported that the tax bill would "[r]educe the pass-through tax rate to 25% regardless of income level. Since 95% of businesses are incorporated as pass-through entities[12] Examples include "sole proprietorships, partnerships and S corporations that currently pay taxes at the individual rate of their owners."[2] whose owners pay taxes as if it were personal income at a much lower rate. This represents a large tax cut for owners that is capital as opposed to labor. Approximately the largest 2% of pass-through businesses represent 40% of pass-through income and today are taxed at 39.6%, the top individual rate."[2]

See also[edit]


  1. ^ a b c d Rogers-Glabush, Julie (2009). IBFD International Tax Glossary (7th ed.). International Bureau of Fiscal Documentation (IBFD). p. 550. ISBN 9789087220570. OCLC 1128093195.
  2. ^ a b c Parlapiano, Alicia (November 2, 2017). "The Five Biggest Changes for Families in the Republican Tax Bill". The New York Times. Retrieved December 3, 2017.
  3. ^ a b c Sahadi, Jeanne (December 2, 2017). "Here's what's in the Senate tax bill - and how it differs from the House's bill". CNN Money. Retrieved December 3, 2017. The House bill dropped the top income tax rate to 25% from 39.6%, while prohibiting anyone providing professional services (e.g., lawyers and accountants) from taking advantage of the lower rate. It also phases in a lower rate of 9% for businesses that earn less than $75,000. The Senate bill lowers taxes on filers in pass-throughs by letting them deduct 23% of their income, up from 17.4% originally. The 23% deduction would be prohibited for anyone in a service business—except those with taxable incomes under $500,000 if married ($250,000 if single). Prevent abuse of pass-through tax break: If the owner or partner in a pass-through also draws a salary from the business, that money would be subject to ordinary income tax rates. But to prevent people from recharacterizing their wage income as business profits to get the benefit of the pass-through deduction, the Senate bill would automatically limit the deduction to half of the W-2 wages of the pass-through entity or its share to the individual taxpayer. The W-2 rule would not apply, however, if the filer's taxable income is under $500,000 if married, $250,000 if single.
  4. ^ a b Dylan Scott; Tara Golshan (December 2, 2017). "Republicans still have a lot of differences between the House and Senate tax bills to hash out: The House and Senate now have to pass the same tax bill. Here's where the two diverge". Retrieved December 3, 2017.
  5. ^ "Sole Proprietorships | Internal Revenue Service".
  6. ^ "9 facts about pass-through businesses". 15 May 2017.
  7. ^ 26 USC 1361-1368..
  8. ^ a b c Krupkin, Aaron; Looney, Adam (May 15, 2017). 9 facts about pass-through businesses (Report). The Brookings Institution.
  9. ^ "IRS Collects $3.2 Billion from Son of Boss; Final Figure Should Top $3.5 Billion". U.S. Internal Revenue Service (IRS). March 24, 2005. Retrieved December 3, 2017.
  10. ^ a b c d Berman, Russell (June 7, 2017). "The Death of Kansas's Conservative Experiment". The Atlantic. Retrieved June 7, 2017. Republicans in the state legislature on Tuesday voted to reverse Governor Sam Brownback's signature tax cuts, dealing a blow to the kind of fiscal policy the Trump administration wants to enact nationally.
  11. ^ Max Ehrenfreund (February 22, 2017), "Republicans' 'real-live experiment' with Kansas's economy survives a revolt from their own party", The Washington Post, retrieved February 25, 2017
  12. ^ a b Gelles, David (September 28, 2017). "In Trump Tax Plan, a Windfall for Businesses Large and Small". The New York Times. Retrieved December 3, 2017.