What is a pass-through entity? What is a pass-through entity?

What is a pass-through entity?

Nowadays, ensuring money flow is secure and seamless can be a top priority for many businesses. This is where a pass-through entity can come in handy, and although registered in much the same way as a business is, the sole intention of this type of formation is to provide a stable and functional platform for transferring cash from the business to the company owner. These entities are becoming more and more popular as businesses grow, and in this article, we will be exploring the key traits of a pass-through formation, what they are, and how they work.

What does a pass-through entity mean?

In the simplest of terms, a pass-through entity is a type of business, typically an LLP (Limited Liability Partnership), LLC (Limited Liability Company), sole proprietorship, or S Corp, that has been established to enable an external entity to process their funds through the flow-through. Pass-through means to ‘transfer using,’ so if you imagine that a business has a name established to provide its services and then a secondary enterprise set up to receive, process, and transfer funds to specific recipients, a pass-through entity steps into the spotlight.

There are rules and regulations surrounding the operation of pass-through entities simply to avoid the risk of fraudulent activity, so it’s always a good idea to get in touch with a professional company formation firm to ensure that all of your practices are above board and legal.

How many states have pass-through entities?

As of 2023, 32 states within the US provide the framework for pass-through entities to practice. Additionally, one locality has adopted these rules, and so when establishing a flow-through within the United States, business owners will find themselves with plenty of options, even if they don’t live in the region. These states agreed upon a legal set of rules to govern and oversee PTE tax (pass-through entity taxation). To comply with this legislation, any interested company must abide by specific parameters and rulesets to be eligible for consideration. Once approved (which is much easier to do with the help of a company formation service), the processes involved are considered fairly straightforward, with a separate taxation submission required for any pass-through entity.

What types of business structures are considered pass-through entities?

Several business structures, including LLPs, LLCs, sole proprietorships, and S Corps, can typically apply for pass-through entity status. As you may be aware already, these types of companies can also be registered for use outside of pass-through entity activities, but they are the most commonly used when establishing a flow-through entity.

Depending on your specific needs and requirements, some business structures may be better suited than others. For example, if you run a business with a partner, then an LLP may be most beneficial, as you will each be responsible for your own self-assessment and tax submission whilst sharing the responsibility of the pass-through entity (with financial details being provided within the self-assessment to detail shares, profits and so on). This information is provided on the individual’s tax return, negating the need to create a separate form for the pass-through entity in most cases.

How are pass-through entities taxed?

Unlike registered corporations that are legally required to submit a dedicated tax return for the entity in question, a pass-through entity operates a little differently. For example, if it is registered as an LLP, then each designated member of the partnership will be able to provide any and all information on allocated shares, profits, losses, and expenses via their own tax return submission. Not only is this much easier to manage, but it’s also notably quicker as the need to submit a separate return for the pass-through entity is all but negated.

In some cases, the federal income tax system in the United States may request an audit for a pass-through entity, and this is why hiring a dedicated company formation team can be beneficial, as they can undertake all relevant accounting and bookkeeping to simplify any auditing process.

Do pass-through entities file tax returns?

The simple answer would have to be yes, and no. Yes, because detailed information will be provided by the member or members of the pass-through entity via their own tax return, and no, because this information doesn’t need to be submitted as the PTE itself. Within the individual’s tax return will be a section detailing their allocated shares, profits, and split expenses or costs, as well as the name of the legal entity that they are trading as, alongside the name of the pass-through entity. This means that any earnings, as can any tax owed, can be calculated.

Pass-through entities, therefore, don’t need to submit a dedicated tax return, but the information relating to the transactions that take place via the PTE will be noted within the individual’s submission. For example, if the co-owner of a PTE has their own business, as well as a shared one that uses the flow-through entity, they will have space on their tax return to include details of the former, as well as the pass-through entity that they are associated with, providing information on their overall income as a whole. This allows the member to keep their earnings private, which is another benefit of using a pass-through entity, as most other incorporated companies will display their annual turnover online via the relevant database in the United States.

Set up your company in the United States with Workhy

Most business owners will want to focus on their products and services and won’t find much time for handling taxes and technical processes. This is why so many turn to the services of Workhy, a dedicated team of specialists that can assist with a wide range of company formation, taxation, and bookkeeping solutions. From establishing US-based companies online without the need for an owner to visit the country right through to EIN and ITIN applications, opening online bank accounts, providing registered agents, and more. Visit our website now to start your entrepreneurial journey in the United States!

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