San Jose, CA Pass-Through Entity Tax Lawyer

Attorney Assisting With Small Business Tax Issues in San Francisco and Santa Clara County

Business owners make important decisions every day that affect their company's bottom line. For any small business, it is important to ensure that the right structures are in place to ensure that the company can function on a day to day basis, but also to minimize tax obligations and make use of the available tax deductions. Many small business owners can benefit by establishing their company as a pass-through entity, but it is important to consult with an attorney to understand the benefits and risks of doing so.

At John D. Teter Law Offices, our tax attorney has more than 30 years of experience assisting clients with complex tax issues. We can help you determine whether a pass-through structure is right for your business and ensure that you meet the legal requirements for creating the type of business entity you choose.

What Is a Pass-Through Entity?

In a pass-through entity, the business itself does not pay taxes on its earnings. Instead, the company's profits and losses are "passed through" to the owners and taxed as part of their personal income tax. This can help avoid the potential for double taxation that is present for some corporations, in which a company pays corporate taxes on its income, and the shareholders also pay income tax on dividends earned from the stock they hold.

Pass-through business entities include:

• Sole proprietorships - This type of business is not considered separate from its owner's personal assets. The net income earned by the business is reported on the owner's personal income tax return, and the owner will also typically be required to pay self-employment taxes.
• Partnerships - In a business with multiple owners, the business will report income, and each of the partners will pay taxes depending on their distributable share of the business's taxable profits and losses, usually the partner's percentage interest in the partnership. Partners will also typically be subject to self-employment taxes.
• LLCs - A limited liability company can elect to be taxed as either a corporation or as a partnership. If the latter option is chosen, the LLC will function as a pass-through entity. A single-member LLC that does not elect to be taxed as a corporation is considered a "disregarded entity" that is taxed the same as a sole proprietorship.
• Corporations - An S corporation that elects to be taxed under subchapter S of the Internal Revenue Code, Chapter 1 functions as a pass-through entity, but a C corporation will pay corporate income taxes.

Benefits and Risks of Pass-Through Entities

Structuring a business as a pass-through entity can avoid double taxation, and it may also allow owners to be taxed at a lower rate than the corporate tax rate. In addition, the Tax Cuts and Jobs Act (TCJA) of 2017 created a 20% tax deduction for pass-through entities. This means that only 80% of properly structured pass-through business income will be subject to income taxes.

While a pass-through entity provides some tax benefits, it may also present some risks for business owners or partners. An owner or partner will be subject to tax liabilities on the profits earned by a business, even if the business's income was not distributed to the partner. However, the majority partner or shareholder of a business will often be able to control the amount and timing of distributions to ensure the ability to cover the tax obligations of the business.

Those who expect to take advantage of the pass-through tax deductions provided by the TCJA should also be aware of the potential limitations of these deductions. Certain types of service businesses, including health providers, law firms, financial services, athletics, and performing arts, will only be eligible for the 20% deduction if the owner earns a taxable income of less than $157,500 as a single person or $315,000 as a married couple filing jointly. The deduction is reduced for incomes above these thresholds, and it is not available for incomes higher than $207,500 for a single person or $415,000 for a married couple filing jointly.

Contact a Bay Area Business Tax Attorney

Business owners may be able to improve their company's bottom line by structuring their business as a pass-through entity, but it is important to understand the requirements that must be met and the potential risks involved. John D. Teter Law Offices can help you determine the best options for your business and ensure that you are taking advantage of the tax deductions and benefits available to you. Contact us today at 408-866-1810 to schedule a consultation.