Final answer:
Owners of flow-through entities must report their share of income and deductions on their personal tax returns through a Schedule K-1, whether or not they received a distribution. The income is taxed at their individual rates, and losses can offset other personal income, albeit they may pay taxes on income not yet distributed.
Step-by-step explanation:
Owners, partners, and shareholders of flow-through entities report income and deductions on their personal tax returns, regardless of whether a distribution is made. Flow-through entities, such as S-corporations, partnerships, and LLCs treated as partnerships for tax purposes, pass their profits and losses directly to their owners. Each owner includes their share of the entity's income or losses on their tax return and pays taxes accordingly. This happens annually when the entity provides each owner with a Schedule K-1 detailing their respective share of the income or deductions.
Income from flow-through entities is taxed at the individual owners' tax rates, and it is subject to self-employment taxes if the income is earned from active participation in the business. Distributions are not necessary for income to be reported, meaning owners might pay taxes on income they have not actually received if the business retains its profits. This differs from C-corporations, where profits are taxed at the corporate level and dividends issued to shareholders are taxed again at the individual level, known as double taxation.
The advantage of flow-through entities is that they avoid double taxation while allowing business losses to offset other personal income. However, shareholders in these entities must consider their tax planning carefully since they are taxed on income regardless of distributions.