Overview of Pass-Through Entities
A pass-through entity passes all income and losses to the owners. The owners then report this income and pay taxes on their personal tax returns. Pass-through entities include sole proprietorships, partnerships, limited liability companies, and S corporations. These entities avoid double taxation, meaning the income is only taxed once on the owners’ personal returns.
Impact and Statistics
Pass-through entities account for over 90% of private sector businesses and 40% of private sector payroll. They are most common in services like healthcare, construction, and food service where over 60% of businesses are pass-through entities.
Tax Implications and Management
Although pass-through entities themselves do not pay income tax, they often still must file tax returns. The owners pay personal income tax on their share of the pass-through income, regardless of whether they actually received distributions. Some states also charge franchise taxes or fees. The owners are also responsible for self-employment taxes.
The 2017 Tax Cuts and Jobs Act provided a 20% deduction on qualified business income for many owners of pass-through entities. This deduction can result in major tax savings. However, the complex qualification rules mean each business situation is different.
Properly managing a pass-through entity involves understanding the tax implications. Though pass-through taxes are based on profits rather than distributions, some states allow or require the entity to pay taxes directly. In those cases, there is still only one level of tax, but the entity handles payment.