What is a Pass Through Entity?

Pass Through Entity - What is it and what does it mean?

Most businesses do not have to pay income taxes on the corporate level. Instead the profits from their business flows through (or passes through) to the owners of the company where it is eventually taxed.

Types of Pass Through Businesses

  • Sole Proprietor
  • Partnership
  • Single Member LLC
  • S Corporation

An example of a non pass through entity would be a C Corporation. In a C Corporation the company pays taxes on the profit of the business at the corporate level.

Basic Concept: If you have a pass through entity you have income and expenses related to the business that are reported on the business tax return (Schedule C, 1065, 1120S). The profit from those businesses are then reported on a personal return where the taxes are paid.

Here is the tax treatment for the various entity types:

Sole Proprietorship or Single Member LLC

File business information on a Schedule C on a personal tax return (Form 1040).

Partnership or Multi Member LLC

File business information on Form 1065 and then each partner will receive a K1 with their share of activity which will be used to report and pay taxes on the business activity on a personal tax return (Form 1040).

S Corporation

File business information on Form 1120S and then each owner will receive a K1 with their share of activity which will be used to report and pay taxes on the business activity on a personal tax return (Form 1040).

C Corporation (Not Pass Through Entity)

File business information on Form 1120 and then pay taxes at the corporate level.

Now you know what a pass-through entity is. Majority of small business owners in the US operate using a pass-through entity.

Check out our episode on the Small Business Tax Savings Podcast for more on this topic!

How should I structure my business with multiple owners?

How should I structure my business with multiple owners?

We often times get business owners that reach out to us that have multiple owners in their company, wondering what the best way is to structure their business.

In this specific article we are assuming an S Corp structure is desired prior to it reaching the owners personal tax return. If you don’t know what an S Corp is, we will dig into that in future post but in a nut shell it is a tax strategy to help limit the amount paid in self employment taxes.

With that assumption there are two main options we typically suggest. Note that this also assumes that all owners are going to be active within the business (not just silent investors).

Option 1

Setup company as an S Corporation with each owner as a shareholder in the business personally.

  • Advantages
    • One company, one tax return, one payroll account
    • Easier to setup and less maintenance
    • Cheaper
  • Disadvantages
    • Various owners cannot take advantage of tax strategies that help them but not other owners.
    • If you have multiple businesses you may need multiple S Corps.
    • Less Flexibility

Option 2

Parent company is a partnership with each owner having their own S Corp that owns their percentage in the partnership.

  • Advantages
    • Each partner can utilize tax strategies as they see fit (hire kids, business automobile, etc).
    • If they own multiple businesses their personal S Corp can hold the ownership in those and all business income will flow through their S Corp prior to reaching them.
  • Disadvantages
    • Multiple companies, multiple tax returns, multiple payroll accounts
    • More to setup and maintain
    • More expensive

 

With that being said, lets run through some scenarios.

Scenario 1: Two owners and one wants a Mercedes for his business vehicle and the other wants a Prius. In option 1, there could be some conflict because the price for these are vastly different and the person with a Prius does not get as much out of the tax strategy. However in option 2, it doesn’t matter because they can hold the vehicle ownership in their personal S Corp and do whatever they want with affecting the other owner.

Scenario 2: Two owners in which they are 100% active in the business with no other ventures. In option 2 they would have to pay for a tax return for the partnership and then two S Corps. They would also have to run two separate payrolls for each S Corp. Rather if they chose option 1 it would be one business return and one payroll which means it is more cost effective.

Generally if the owners have multiple businesses they participate in, we will suggest option 2 since they will want all income to pass through an S Corp anyways so they can avoid a portion of self employment taxes.

If the owners are on the same page as far as spending and tax strategies, we typically say option 1 is fine for them to help minimize costs and maintenance.

Either way, there is no one size fits all for every situation so be sure to discuss with a tax professional to ensure you get things right from the beginning.

Check out our episode on the Small Business Tax Savings Podcast for more on this topic!

Paycheck Protection Program (PPP) Forgiveness Cheat Sheet

Coronavirus (COVID-19) - Paycheck Protection Program (PPP) Forgiveness for Small Businesses

LAST UPDATED: 6/22/20

As you know, things are constantly changing with the Paycheck Protection Program. Our goal is to create an outline here of the things you need to know about when it comes to forgiveness.

Bookkeeping is the back bone to every business. With that being said, bookkeeping can quickly become an incredibly hard task unless you follow these four simple rules.

Facts

  • Time to Use Funds: 24 Weeks or December 31st (Whichever comes first) — You have an option to use 8 weeks if you received funding prior to June 5th
  • Required Amount Used on Payroll: 60%
  • Amount NOT Forgiven Loan Term: 5 Year Term at 1% (accruing immediately) with 6-month payment deferral from the date of loan disbursement

Costs Eligible for Forgiveness

  1. Payroll Costs (Must be at least 60%):  Paid or incurred during the covered period including: Salaries, wages,  employee health insurance contributions by employer, employee retirement plan contributions by employer, and state and local payroll taxes. NOTE: Capped at $100k Annualized per Employee and employer share of FICA is not included in the costs.
  2. Self Employed/Owner Payroll Max: $15,385 (8 Week Period) or $20,833 (24 Week Period) – They are also capped by the amount of their 2019 employee salary and retirement contributions. NOTE: Owner health insurance is no longer figured into the eligible costs for forgiveness. Non-owner health insurance still is.
  3. Max 40% of: Mortgage interest, Utilities, Rent

Employee Headcount or Pay Reduction

Your forgiveness amount may be reduced if:

  1. You reduce employee pay in excess of 25% (Salary or Hourly)
  2. You reduce employee headcount or Full-Time Equivalent (FTE). There are two methods to calculate FTE:
    • Long Method: Average hours each employee paid per week, divided by 40 and rounded to nearest 10th with a maximum of 1.
    • Simple Method: 40+ Hours = 1 FTE and <40 Hours = .5 FTE
    • Example 3 employees working 25, 35 and 42 hours per week. Using the long method your FTE would be 2.5 and using the simple method it would be 2.
  3. If you restore to original numbers by December 31st or end of the covered period (date you file your application) you are fine.
  4. Exceptions:
    • Inability to rehire individuals or similarily qualified individuals (or employee denies offer to come back at original level)
    • Able to document inability to return to the same level of business activity as business was operating at before 2/15 due to COVID restrictions.

Loan Forgiveness Process

  1. Complete and Submit Forgiveness Application to Bank (SBA Form 3508 or 3508EZ) within 10 months after the last day of the covered period. NOTE: A borrower may submit a loan forgiveness application before the end of the covered period if the borrower has used all of the loan proceeds for which they are requesting forgiveness.
  2. Lender has 60 days from receipt of application to issue a decision to SBA.
  3. SBA will deduct EIDL advance amounts from the forgiveness amount.

Check out our episode on the Small Business Tax Savings Podcast regarding this topic!

What Bookkeeping Rules Do I Need to Follow?

Top 4 Bookkeeping Rules to Follow

Bookkeeping is the back bone to every business. With that being said, bookkeeping can quickly become an incredibly hard task unless you follow these four simple rules.

1. Separate Business Bank Account

Have a separate bank account (and credit card, if applicable) specifically for your business. This is important even for you sole proprietors. Regardless of your business setup, this is vital.

If you are unable to get a credit card under your business name, make sure you dedicate one personal card strictly for business use only and use the payments to it as a reimbursement.

2. No Commingling

No personal expenses on the business bank or credit card account. In the rare occasion that you accidentally put a personal expense on the business account, record it as an owners draw or reimburse the business for it.

3. Keep Your Receipts

Store them in a file in your office or take a picture of them and save them in the cloud. This is vitally important in the event of an audit.

On each receipt write on it: who, what, where, when, why, and how much. Not only does this help backup the business purpose but it also reminds you in case you forget down the road.

4. Ditch the Cash

Cash is hard to track and prove. In the rare event cash is your only payment option, be sure to get a receipt so you can properly document the business expense.

Check out our episode on the Small Business Tax Savings Podcast regarding this topic!