What Is Pass-Through Taxation?

As you grow your business, you will learn a variety of new terms and topics related to running your company. These concepts may seem confusing at first, but understanding them is important to helping you make the best strategic decisions for your business.

One topic that you may have heard relating to taxes is “pass-through entity,” which can affect how you are taxed—and how complicated filing is. Learn more about what this term means and what pass-through taxation involves. 

What Is a Pass-Through Entity?

A pass-through entity is an organization that is not taxed because the tax burden is “passed through” to the owner. Pass-through entities include sole proprietors, partnerships, LLCs, and S-corps. 

Operating a pass-through entity is often considered easier for freelancers and solo entrepreneurs because they only have to worry about paying their personal income tax rather than covering their taxes and taxing the earnings of the business. 

You do not need to fill out any specific paperwork through the IRS to be considered a pass-through entity. When you file your taxes, you will select how your organization operates and will be taxed accordingly. 

What Is Pass-Through Entity Taxation? 

Because pass-through entities aren’t taxed, the main form of taxation related to this business comes from personal income tax. The business owners will have to pay self-employment tax, which covers the costs of Social Security and Medicare. The self-employment tax rate is 15.3%. However, you can deduct half of what you contribute from your taxes. 

The self-employment tax is just the base amount that owners of pass-through companies need to pay when they file. These individuals are also responsible for their state and local taxes, which may be added to the filing process.  

When Do Owners of Pass-Through Companies Pay Taxes?

Once you remove the burden of paying taxes through your company, you can focus on paying your own self-employment taxes. While a major employer would take out your Social Security and Medicare tax for you, you are responsible for paying that yourself as a business owner. 

The IRS recommends paying estimated quarterly taxes based on what you earned for each quarter. Each year, the IRS sets dates for when these quarterly taxes are due. Paying your taxes quarterly can reduce the burden of paying a full tax bill at the end of the year.  

How Can You Pay Your Pass-Through Taxes?

You can pay your taxes as you normally would when you file in the spring, or you can pay them online through the IRS for quarterly payments. The IRS accepts checks, direct deposits from your bank, and even credit cards (though some cards come with steep fees). 

The IRS will give you a confirmation number with each quarterly payment so you can track the amount you paid and the date you made the payment. 

Prepare for Tax Season With Lendio

If this is your first year as a sole proprietor or partnership, navigating the tax process can get complex. At Lendio, we provide free and easy tools for small business owners to get their bookkeeping in order. Check out our app and see how it can help you.

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The information provided in this post does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this post are for general informational purposes only. Readers of this post should contact their tax professional to obtain advice with respect to any particular tax matter.