Pass-Through Taxation: What Are Its Benefits?

One of the key decisions you have to make as a business owner is to decide on the structure of your business.

This decision usually dictates two consequences: the legal requirements and advantages of the structure and how it will be taxed.

When it comes to business taxes, for most entrepreneurs, a pass-through structure allows you to enjoy the benefit of paying a single tax for your business. 

With businesses going through tough times, a pass-through structure allows you to retain most of your income that can be channeled to more important issues.

To help you take your business to the next level, we have created this article that highlights the benefits of pass-through taxation that are available to business owners.

What is Pass-Through Taxation?

Pass-through taxation happens when taxes are skipped by one entity and then passed over to another. This means that the business refrains from paying those taxes directly when taxes are passed through.

The secondary entity to which the taxes are passed over is the business owner.

Many small businesses operate with this structure because it helps them avoid paying taxes twice, thus ensuring business owners have more funds for their operations.

Think about how money moves in a business. The business generates revenue by selling goods or services. The business is supposed to pay taxes on the income it generates.

When the owner gets their share from the profits, they also have to make tax payments to the relevant authorities.

Pass-through taxation allows businesses to pass their revenue directly to the business owner instead, thus preventing double taxation.

But if you want to enjoy the benefits of pass-through taxation, you should consider starting the appropriate business structure with a filing agency like Inc Authority. Here’s an Inc Authority review to help you understand the right structure to choose.

Which Entities Enjoy Pass-Through Taxation Benefits?

There are certain entities that can enjoy pass-through taxation. Such entities don’t pay income taxes directly. Instead, the business owner pays the tax with their personal income tax returns.

The following entities allow pass-through taxation.

Sole Proprietorship

A Sole Proprietorship is owned by a single individual. The business owner is entitled to all the income from the business.

The Sole Proprietor is also liable for all the business’s liabilities, such as taxation. The owner reports the business profits/losses and includes this declaration with their personal income tax return.

Partnership

A Partnership is owned by several people. Each owner is entitled to a share of the business’s profits and losses based on their ownership percentage.

Partners in a business receive their share of the business income and have to pay for that in their personal income tax return. However, the business doesn’t pay any taxes on its profits.

Limited Liability Company

LLCs are pass-through taxation entities where the income of the business is passed through to the owners’ personal tax returns.

An LLC that’s owned by one person is treated like a Sole Proprietorship, and the business income tax is passed to the business owner.

On the other hand, an LLC that’s owned by several people is treated like a Partnership, and the partners are taxed at a personal level based on their income from the business.

S-Corporations

An S-Corp is owned by shareholders and can have as many as 100 of them. The tax liability of a shareholder is determined by their stake in the business. Unlike C-Corporations, S-Corps allow pass-through taxation, and the shareholders have to pay taxes on their share of the profits from the business.

The Benefits of Pass-Through Taxation

Now that you know the business structures that qualify as pass-through entities, let’s take a look at the pass-through taxation benefits they bring.

Generating More Income

Entrepreneurs set up a business with the goal of generating profits. However, what matters is not just the income you generate through sales but also how much you retain in the end.

Taxes take away a huge portion of your income if it’s taxed at the business level. However, skipping this part and paying business taxes at the individual level reduces this impact, resulting in more net income.

More Funds to Build the Business

One of the powerful pass-through taxation benefits that businesses enjoy is that it leaves them with more funds to invest in the business.

When your tax burden is not high, you will have more funds to invest in new technologies to improve service delivery. You can also keep your workers happy by increasing their salaries and benefits.

This is impossible without sufficient funds, and you could lose your customers and top employees to your competitors.

Helps Attract More Funding

The good thing about having a high net income is that it helps you attract more external funding to your business. When you can prove that your business generates more revenue after taxes, it becomes easier to convince other people to invest in it.

On top of that, you can also secure business loans at lower interest rates.

Keeps You in Business Longer

Having more money available in your reserves allows you to stay in business during tough times. The additional income gives you more flexibility and allows you to weather the storms that can put you out of business too.

We all saw how the COVID-19 pandemic forced many people out of business. Businesses with a high net income were able to stay in operation a little longer as it helped them sustain themselves when business was hard to come by.

Conclusion

It’s easier to grow a business when you have more funds available for your operations. And that’s exactly what you can get from pass-through taxation. 

Pass-through taxation entities enable you to pay only the tax on your personal income, while the business pays no tax on its income. The tax saved can be deployed to help scale and sustain your business.

 Author Bio:Brett Shapiro is a co-owner of GovDocFiling. He had an entrepreneurial spirit since he was young. He started GovDocFiling, a simple resource center that takes care of the mundane, yet critical, formation documentation for any new business entity.

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