Whose Income Do You Pay Taxes On?
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If you own 10% of a business, and it made $1 million of profits this year, how much do you have to pay in taxes on that income?
In the US, there are two common answers to this question. One is that your income includes 10% of the business’s income, so you have $100,000 of income and pay, say, $37,000 of taxes on it (at the top federal income tax rate of 37%). This is the normal way that, for instance, law firms are taxed: A partner who owns a one-tenth share of the law firm counts 10% of the firm’s income in her income, and pays taxes on it. It’s the normal way that most hedge fund managers are taxed. More generally, it’s the normal way that partnerships, limited partnerships, many limited liability companies and a lot of corporations1 are treated: Their income is treated as taxable income of their owners, who report their share of the income on their individual tax returns. They are called “pass-through entities,” because their income is passed through to their owners.