Understanding Pass-Through Entity Taxation: Save Thousands in Taxes

Pass-through entity taxation is a concept that might sound complex at first, but it's actually a game-changer for small business owners. In this blog, we'll break down what pass-through entity taxation is, why it's important, and how it can help you save thousands of dollars in taxes. So let's dive in! 

What is Pass-Through Entity Taxation? 

Pass-through entity taxation is a relatively new state tax code that allows small businesses to pay their state taxes at the business entity level instead of on their personal tax returns. This means that businesses can elect to have the assessed and paid state tax at their business level — whether they are an S corporation or a partnership. 

Why is it Relevant? 

Since the implementation of the Tax Cuts and Jobs Act in 2017, the state tax deduction that could be taken on personal tax returns has been limited to $10,000 which includes income tax, property tax, and sales tax. This has been a significant blow to small business owners who used to benefit from deducting significant state taxes. With pass-through entity taxation, small business owners can now get a deduction for the state taxes paid at the business level. 

How Does it Work? 

Let's say you have a small business in Illinois, and your individual state tax rate is 4.95%. With pass-through entity taxation, your business's state tax rate would also be 4.95%. By paying the state tax at the business entity level, you can deduct the state tax from your business's profit, which can lead to significant tax savings. 

To illustrate this, let's consider an example. Imagine your business's profit is $500,000, and you’d pay $25,000 in state taxes. With pass-through entity taxation, figure you can save about a third of that amount in federal taxes, which in this case would be over $8,000. 

How Can Small Business Owners Benefit? 

The benefits of pass-through entity taxation can vary from business to business, depending on individual circumstances and tax rates in each state. That's why it's essential for small business owners to reach out to their CPA (Certified Public Accountant) and have a conversation about whether electing for pass-through entity taxation would be advantageous for their business. 

You don't have to do the math yourself; that's what your accountant is there for! Simply ask your accountant if they have considered electing for pass-through entity taxation for your business. It's a simple question that can potentially save you thousands of dollars in taxes. 

Timing and Coordination 

It's crucial to file your taxes early in the tax season to give yourself enough time and energy to consider the benefits of pass-through entity taxation. The process may involve a change in the timeline and cadence of tax payments, so it's essential to set proper expectations and coordinate the money movement with your accountant. 

Remember, the rates and parameters around pass-through entity taxation can vary from state to state. While it may be a no-brainer in some states like Illinois, it's always wise to have a conversation with your CPA to determine if it's the right move for your business. 

IT Could Mean Big Tax SAvings

Pass-through entity taxation is a valuable tool that small business owners can use to save money on their state taxes. By electing for pass-through entity taxation, businesses can deduct state taxes paid at the business entity level from their profits, leading to significant tax savings. However, it's crucial to consult with your CPA to determine if this strategy is right for your specific business.

Don't leave money on the table—reach out to your accountant today and start taking advantage of pass-through entity taxation! 

We hope you found this blog post helpful. If you have any questions or would like to learn more, feel free to reach out to us by using the ‘Let’s Chat’ button. See how Kaizen CPAs + Advisors can help you.