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
- 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).
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!