Small business guidance – What are flow-through entities and why should I care?

Small business owners have a number of options on how to organize their business for tax purposes. Many small, single owner, businesses are not incorporated, and are deemed “sole proprietors,” in the eyes of the IRS. Other business entities, like C-Corporations, are taxed as a separate entity with distributions to owners taxed a second time as dividends. Still others are deemed “flow-through” entities like S-Corporations and Limited Liability Companies (LLC).

Flow-through entities

Flow-through entities do not pay taxes at the company level. Instead, the business tax return reports the net income to the IRS, but then distributes the taxable income to their respective owners via a K-1 tax form. Each individual owner then reports their share of the K-1 net income on their individual tax return and pays the tax on this and any other personal income.

Generally, business owners like flow-through entities because:

  • The business income is taxed once instead of twice as in the case of C-Corporations.
  • The business format provides owners a level of legal protection that is not available by doing business as a sole proprietor.

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