AOCBA CAPITAL™ EDUCATION CENTER
PASS IT THROUGH.
UNDERSTAND THE BUSINESS. UNDERSTAND THE TAX.
The AOCBA Capital Pass-Through Tax Guide™ helps entrepreneurs understand one of the fundamental concepts of business ownership: how income, expenses, deductions and tax information may move from a business to the people who own it.
PASS-THROUGH TAXATION
THE BUSINESS EARNS IT. THE TAX INFORMATION CAN FLOW TO THE OWNER.
Understanding this relationship is an important part of understanding what it means to own a business.
THE BUSINESS AND THE OWNER ARE CONNECTED.
For many pass-through businesses, the entity itself generally does not pay federal income tax in the same manner as a traditional C corporation.
Instead, taxable items may be reported through to the owner or owners and ultimately affect their individual tax returns.
Millions of small businesses operate through structures whose federal income-tax treatment can involve business income, deductions, gains, losses or other tax items passing through to their owners.
But “pass-through” does not mean “tax-free.” It describes how certain tax items move through the business structure for federal income-tax purposes.
THE BASIC FLOW
FOLLOW THE MONEY. FOLLOW THE TAX INFORMATION.
The exact tax forms differ by business structure, but the underlying concept can be easier to understand when viewed as a process.
BUSINESS STRUCTURE MATTERS
NOT EVERY PASS-THROUGH BUSINESS REPORTS TAXES THE SAME WAY.
The legal structure of a company and its federal tax classification are related—but they are not always the same thing.
SOLE PROPRIETOR
A sole proprietor generally reports business income and expenses on Schedule C attached to the owner’s individual federal income-tax return.
Net earnings from self-employment may also be subject to self-employment tax.
SINGLE-MEMBER LLC
For federal income-tax purposes, a domestic single-member LLC is generally treated as a disregarded entity unless it elects another tax classification.
Depending on the activity and classification, business activity may therefore be reported on the owner’s return.
PARTNERSHIP
A partnership generally files Form 1065 to report its operations and provides partners Schedule K-1 information reflecting their respective shares of applicable tax items.
S CORPORATION
An S corporation generally passes various items of income, loss, deduction and credit through to its shareholders.
Separate rules apply to shareholder-employees, wages, distributions, basis and other matters.
SCHEDULE C
FOR MANY ONE-PERSON BUSINESSES, THIS IS WHERE THE TAX STORY BEGINS.
Schedule C reports profit or loss from a sole proprietorship as part of the owner’s individual federal income-tax return.
BUSINESS ACTIVITY BECOMES TAX INFORMATION.
The owner generally reports gross receipts or sales and then accounts for applicable costs and deductible business expenses.
The resulting net profit or loss can affect the owner’s individual federal tax return and, when applicable, self-employment tax.
BUSINESS EXPENSES
REVENUE IS NOT THE SAME THING AS PROFIT.
Business owners should understand the difference between money coming into the business and the amount ultimately remaining after applicable costs and deductible expenses.
ADVERTISING & MARKETING
Potential qualifying costs associated with promoting the business and attracting customers.
BUSINESS SUPPLIES
Certain supplies and materials used in operating the business may qualify.
PROFESSIONAL SERVICES
Potential qualifying legal, accounting and other professional business costs.
BUSINESS INSURANCE
Certain insurance premiums associated with operating the business may qualify.
VEHICLE & TRAVEL
Qualifying business transportation and travel expenses may be deductible subject to applicable rules.
HOME OFFICE
A qualifying business use of the home may create a deduction when applicable requirements are met.
TECHNOLOGY
Certain software, communications and technology costs used for business may qualify.
OTHER BUSINESS COSTS
Additional ordinary and necessary business expenses may be deductible depending upon the facts and rules.
SELF-EMPLOYMENT TAX
INCOME TAX ISN’T THE ONLY TAX BUSINESS OWNERS NEED TO UNDERSTAND.
For many self-employed individuals, Social Security and Medicare taxes are addressed through the self-employment tax system.
SOCIAL SECURITY + MEDICARE
The IRS currently states that the self-employment tax rate is 15.3%, consisting of Social Security and Medicare taxes.
The detailed calculation depends on net earnings, applicable wage bases and other tax rules.
SCHEDULE SE
Schedule SE is used to calculate self-employment tax on applicable net earnings from self-employment.
Self-employed individuals may also be able to deduct the employer-equivalent portion of self-employment tax when calculating adjusted gross income.
Estimated tax payments may also become important because business owners often do not have income tax automatically withheld from business earnings.
QUALIFIED BUSINESS INCOME
PASS-THROUGH OWNERS SHOULD KNOW THE QBI CONVERSATION.
Section 199A can provide eligible owners of qualifying pass-through businesses a deduction based on qualified business income, subject to detailed rules and limitations.
THE DEDUCTION IS NOT SIMPLY “20% OF EVERY BUSINESS.”
Eligibility and calculation can depend on taxable income, the nature of the business, qualified business income, wages, qualified property and other factors.
Partnerships and S corporations generally pass information needed for the QBI calculation to partners or shareholders rather than claiming the individual QBI deduction at the entity level.
Because the rules can be complex, business owners should have their individual circumstances reviewed by a qualified tax professional.
THE OPERATING SYSTEM
GOOD TAX PREPARATION STARTS LONG BEFORE TAX SEASON.
A business owner needs a system for capturing what happens financially throughout the year.
BUSINESS BANKING
Keep business activity organized and distinguishable from personal spending.
REVENUE
Maintain records supporting sales, payments and other business income.
EXPENSES
Record business expenditures and preserve supporting documentation.
ACCOUNTS
Regularly compare business records with bank, credit-card and payment-processing activity.
DOCUMENTS
Maintain receipts, invoices, contracts and other important business records.
FINANCIAL REPORTS
Use bookkeeping and financial reports to understand business performance throughout the year.
ESTIMATED TAXES
Understand whether estimated federal or state tax payments may be required.
TAX RECORDS
Organize information so the business and its tax professional can prepare accurate filings.
AOCBA CAPITAL™ CONNECTION
YOUR TAX RECORDS CAN ALSO TELL THE STORY OF YOUR BUSINESS.
Tax preparation and capital preparation are not the same thing—but both depend heavily on organized, credible business information.
When a business eventually pursues financing or investment capital, lenders, investors and other capital providers may evaluate financial history, revenue, expenses, profitability, tax information, cash flow and supporting documentation.
That makes financial organization part of both business readiness and capital readiness.
BUSINESS OWNER CHECKLIST
BUILD THE TAX SYSTEM WHILE YOU BUILD THE BUSINESS.
Use these questions to identify areas that may deserve attention before tax season arrives.
KNOW WHEN TO BRING IN A PROFESSIONAL
BUSINESS OWNERSHIP DOESN’T MEAN DOING EVERYTHING YOURSELF.
Different professionals serve different roles in helping a business owner build and maintain the financial and tax infrastructure of the company.
BOOKKEEPER
Helps maintain organized transaction records, accounts and financial information.
ACCOUNTANT / CPA
May assist with accounting, financial reporting, tax planning and other professional accounting services.
TAX PROFESSIONAL
Can help evaluate tax obligations, elections, filing requirements and tax-return preparation.
ATTORNEY
Can advise on legal structure, agreements, ownership, governance and other legal matters.
IMPORTANT TAX & EDUCATIONAL NOTICE
The AOCBA Capital Pass-Through Tax Guide™ is provided for general educational purposes only. It is not intended to provide individualized tax, accounting, legal, investment or financial advice and should not be relied upon as a substitute for advice from qualified professionals.
Tax treatment depends on many factors, including business structure, federal tax classification, elections, ownership, income, deductions, basis, activities, compensation, distributions and individual taxpayer circumstances. State and local tax treatment may differ from federal treatment.
Tax laws, thresholds, forms, regulations and administrative guidance can change. Business owners should consult a qualified CPA, enrolled agent, tax attorney or other appropriate professional regarding their individual circumstances and should verify current requirements before making tax decisions.
PASS-THROUGH TAX FAQ
UNDERSTAND THE BASICS. ASK BETTER QUESTIONS.
What does “pass-through” mean?
Is an LLC automatically a pass-through business?
What is Schedule C?
What is self-employment tax?
Does having a business mean every purchase becomes a tax deduction?
What is the Qualified Business Income deduction?
Why does tax organization matter for capital readiness?
Does AOCBA provide individualized tax advice?
AOCBA CAPITAL™
DON’T JUST START A BUSINESS.
UNDERSTAND THE BUSINESS YOU OWN.
Business ownership creates more than an opportunity to earn income. It creates financial, operating, recordkeeping and tax responsibilities that every owner should understand.