Your question:
I can understand why a taxpayer wants to show pass-through losses. But why would they show income?
Linda says:
A lender recently asked why the borrower would report a POSITIVE figure from a pass-through, which would require they pay more taxes. The prior two years they had passed through losses on their 1040 Schedule E. Her query ended with the note: "I am not quite sure about the Sch E Pass-Throughs, could you shed some light???"
It’s time to open up that Partnership/Corporation manual and read the first couple of pages in the Partnership and S Corporation sections. Owners of pass-through entities (partnerships, LLCs, SCorporations) must include in their personal return on Schedule E their share of the taxable income or loss…whichever it is.
When the pass-through entity is real estate, it is not unusual for it to be pushing a loss through. But if it is an active business that is an LLC, for example, let’s hope it is making money! And often S Corporation owners will show significant pass-through income which they take home as a capital distribution instead of paying the same amount in wages. This allows them to pay less in payroll taxes.
So the pass-through’s are not just tax advantaged activities to bring losses into the personal return, although sometimes that is the result.
Open your manual and read the recommended pages (can’t give you page numbers because it may have changed since the manual you received). Take a look at the sample partnership and s corporation returns (they are both active businesses) and read this explanation.
