Tax Court Rules S Corp Payouts Are Wages. Owners treat payments as distributions instead of payroll to reduce their payroll tax. But Tax Court disagrees
S corporations are a flow-through entity is a legal entity where income flows through to investors or owners and treated as the income of the investor or owners.
Flow-through entities are also known as pass-through entities or fiscally-transparent entities. 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, S corporations flow-through entities are considered “non-entities” because they are not taxed; rather, taxation “flows-through” to another tax return.
Common types of FTEs are S corporations 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 (LLC).
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 form K-1 (or Schedule K-1).
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 S corporations, partnership, under which the income or expense is generally regarded as income or expense of the participants under the transparency principle.” 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.
For federal income tax purposes, there is no such thing as being taxed as an LLC or Sub S. Both are treated by the IRS as pass-through entities which are business entities in which income is passed through to its owners and taxed at their personal tax rate. This method allows businesses to avoid double taxation and potentially reduce their overall taxes owed. However, a single member LLC is taxed as a sole proprietor and will incur additional payroll tax, unlike Sub S. An LLC is not a corporation, it’s a partnership. Talk to an Accountant before you decide.