EDUCBA

EDUCBA

MENUMENU
  • Free Tutorials
  • Free Courses
  • Certification Courses
  • 250+ Courses All in One Bundle
  • Login

Pass Through Entity

By Madhuri ThakurMadhuri Thakur

Home » Finance » Blog » Corporate Finance Basics » Pass Through Entity

Pass Through Entity

Definition of Pass Through Entity

Unlike the other corporate entities, pass through entities are the entities which are not considered as an individual entity for separate tax liability for the income it generates instead of that all the income or profit derived by the entity is transferred to the owner’s account and the same is taxable in the hand of the owner.

Explanation

In the case of a normal corporate entity, the corporate tax is charged on the income derived by the entity and after the appropriation of the same, the remaining amounts are transferred to the shareholders of the company. In the case of the pass through the company which is also known as flow through entity, the revenues are not taxed in the hand of the entity instead the same is taxed directly in the hand of owners or promoters. This way the entity avoids the dividend tax paid during the dividend announced to be paid to the shareholders or investors. This helps in removing the double taxation or could be said as a cascading effect caused due to the dividend tax on the income on which later the income tax is also charged.

Start Your Free Investment Banking Course

Download Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

Examples of Pass Through Entity

Let say person A has a small business or is self-employed. Let say his income from the business is taxed at the rate of 30 percent as the corporate tax rate. But when the personal income of the business owner was evaluated it was found that it will fall into the bracket of 20 % even after accumulating the income of the business. Seeing this opportunity the A person could incorporate a pass through entity and could benefit from the same.

Types of Pass Through Entity

In major, the pass through entity could be divided into three types of business which are namely-Sole Proprietorship, Partnership & S Corporation. These could be defined as:

  • Sole Proprietorship: A sole proprietor is a person who has to own an unincorporated business by himself and all the income & expenses arising from the business is charged on the personal tax return of the person. If the person choses to treat the business entity as a separate corporate entity then in that case such will not be treated as a sole proprietorship business.
  • Partnership: As in the case of a sole proprietorship, the business is solely owned by a single person; in the case of a partnership the unincorporated business is owned by a group of people and the income & expenses are treated in the hands of the individual and not in the separate business entity.
  • S Corporation: This type of corporation is similar to the simple corporate entity where only upto 100 shareholders could exist at the same time. Among the shareholders, there should be no non-residential person as well and a similar type of stock is issued to all of the shareholders of the entity.

How to Form Pass Through Entity?

Entrepreneurs have to analyze their personal income tax rate range before incorporating a pass through entity. To form a pass through entity, the person first need to identify the business in which he wants to engage & take a decision regarding opt for a sole proprietorship or Limited Liability Partnership. In the case of LLP, the same should be registered with the registrar of the state where the person is going to engage his business. In some of the cases, the sole proprietors also need to acquire a license from the states or cities to operate and for the same, they have to register a name and apply for an employee identification number and after the registrations and the permit, the person can start engaging in the business.

Pass Through Entity Tax

In the case of pass through entity, the tax on the income earned is does not directly charged in the hands of the entity but is distributed to the shareholders & owners of the entity, and the income is charged in the personal income tax returns of the individuals. In this way, the entity does not have to pay taxes on the dividend distributed to the shareholders, and hence the double taxation on the same income is avoided. Hence the payment of the taxation on the income of the pass through entity lies completely in the hands of individual shareholders & the owners and not in the hands of the corporate entity.

Popular Course in this category
Sale
Business Valuation Training (16 Courses)16 Online Courses | 80+ Hours | Verifiable Certificate of Completion | Lifetime Access
4.5 (9,576 ratings)
Course Price

View Course

Related Courses
Equity Research Training (17 Courses)Project Finance Training (8 Courses with Case Studies)

Advantages of Pass Through Entity

The small vendors and the small business owners have lots to take advantage from the concept of Pass through Entity and some of the advantages are as follows:

  • The main attraction and advantage towards the opportunity of pass through entity are that it enables the business owners to avoid the double taxation effect of the income generated from the business. Not only the avoidance of the double tax, but the pass through entity also enables the owners to avoid the multilayer tax to be paid in the case of a corporation as the tax is charged as individual tax rates.
  • Depending upon the personal income of the business owners, the rate of tax could be low as it is the same as the tax rate charged to an individual which is mostly higher than the corporate tax.
  • Through pass through entity, the partners are limited but the person could build a huge corporation as much as he wants with thousands of employees and there is no restriction.

Disadvantages of Pass Through Entity

There are some disadvantages as well for operating with a  pass though entity and some of them are as follows:

  • The number of partners could be limited and in most of the cases the tax brackets of the individual hit up the top bracket and the maximum tax are charged from them. In these cases, the marginal tax can charge a high amount of tax.
  • Although whether the company has created successful profit or not but most of the time the income generated through the business is being taxed in the hands of the owner or shareholder of the entity.

Conclusion

The pass through entity or so to say the flow through entity is mostly beneficial for the small business owners in case their person tax bracket hits low and the income generated from the pass through entity is moderate. In this case, the tax charged on the individual amounts low as compare to corporate tax. Forming a pass through entity gives the owner the feeling of owning a corporation without being obligated to the legislations and rules need to be followed for running a corporation.

Recommended Articles

This is a guide to Pass Through Entity. Here we discuss the definition and types of pass through entity along with advantages and disadvantages. You may also have a look at the following articles to learn more –

  1. Entity Beans
  2. Accounting Cycle
  3. LIFO Liquidation
  4. Accounting Information System

All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)

250+ Online Courses

40+ Projects

1000+ Hours

Verifiable Certificates

Lifetime Access

Learn More

0 Shares
Share
Tweet
Share
Primary Sidebar
Finance Blog
  • Corporate Finance Basics
    • BPO vs KPO
    • C Corporation
    • Brick and Mortar
    • Business Entity Concept
    • Bounced Check
    • Capital Maintenance
    • Bridge Financing
    • Business Exit Strategy
    • Callable Bonds
    • Affiliated Companies
    • Certified Check
    • Chattel Mortgage
    • Contingent Beneficiary
    • Debt Collector
    • Closed Corporation
    • Cumulative Voting
    • Consumer Loan
    • Commercial Loans
    • Collateralization
    • Commercial Credit
    • Collection Agency
    • Classification of Financial Markets
    • Class Action Lawsuits
    • Prudence Concept in Accounting
    • Calmar Ratio
    • Asset Classes
    • Audit Evidence
    • Contingent Liability
    • Employee Stock
    • Financial Liabilities
    • Incurred Cost
    • Partial Income Statement
    • Deferred Tax Asset
    • Tax Fraud
    • Non-Operating Income
    • Variable Costing
    • Mixed Cost
    • Prime Cost
    • Regressive Tax Examples
    • Unqualified Opinion of Auditor
    • Bonds Payable
    • Class A Shares
    • Contingent Liability Example
    • Contingent Shares
    • Contributed Capital
    • Brownfield Investment
    • Internal Audit
    • Indirect Taxes
    • Fund Management
    • Fixed Cost
    • Debt Equity Swap
    • Cash Flow Hedge
    • Risk Shifting
    • High Yield Investments
    • General Obligation Bond
    • Forward Market
    • Box Spread
    • Fixed Income Trader
    • Trade Discount
    • Quick Assets
    • Notes Payable
    • Revenue Bonds
    • Euribor
    • Settlement Date
    • Short Covering
    • Short Selling
    • Dividend Examples
    • Time to Market
    • Junior Accountant
    • Commodity Derivatives
    • Flash Report
    • Idle Time
    • Leasehold Improvement
    • Product Portfolio
    • Risk Parity
    • Branch Accounting
    • Credit Enhancement
    • Basis Trading
    • At the Money
    • Accounts Receivable
    • Long Term Investments
    • Negative Goodwill
    • Recourse Factoring
    • Residual Value
    • Short Term Loan
    • Tax Exempt
    • Audit Report Format
    • Cash Investment
    • 457 Plan
    • Audit Procedure
    • Audit Materiality
    • Audit Committee
    • Asset Allocation
    • Non-Cash Expenses
    • Dividend Policy Types
    • Credit Terms
    • Dividend Payable
    • Profit Center
    • Absorption Costing
    • Final Dividend
    • Hybrid Securities
    • Other Current Assets
    • Simple Random Sample
    • Dependency Ratio
    • Effective Duration
    • Loan to Value Ratio
    • Inventory Turnover Ratio
    • Advantages of Ratio Analysis
    • Loss Ratio
    • Delaware Corporation
    • Articles of Incorporation
    • Negative Covenants
    • Statutory Liquidity Ratio
    • Leverage Ratio for Banks
    • Accrued Liabilities
    • Activity Ratio
    • Debt Service Coverage Ratio
    • Return on Investment Ratio
    • Turnover Ratios
    • Cash Conversion Cycle
    • Lumion vs V-Ray
    • Capital Intensive
    • Voided Check
    • Negotiable Instruments
    • Portfolio Optimization
    • 401k Plan
    • Non-Marketable Securities
    • Stock Certificate
    • Treasury Stock
    • Appropriate Retained Earnings
    • Stockholder
    • Share Vesting
    • Shares Issued
    • Preferred Shares
    • Share Buyback
    • Shareholder Types
    • Tax Loss Harvesting
    • Statutory Audit
    • Audit Risk
    • Fund of Funds
    • Accredited Investor
    • Cost Centre
    • Lessee
    • Golden Handcuffs
    • Ordinary Shares
    • Restricted Stock Units
    • Goodwill Valuation
    • Share Classes
    • Lessor
    • Preferred Dividends
    • LIFO Liquidation
    • Dilutive Securities
    • Restructuring Cost
    • Non-Cumulative Preference Shares
    • Pass Through Entity
    • Management Discussion and Analysis
    • Premium on Stock
    • Leveraged Loans
    • Dividend
    • Dividend Policy
    • Financial Reporting Objectives
    • Financial Reporting
    • Internal Controls
    • Capital Investment
    • Debt to Equity Ratio
    • Dividend Growth Rate
    • Market Capitalization
    • Deal Origination
    • Importance of Working Capital
    • SWOT Analysis
    • White Knight
    • Root Cause Analysis
    • Realized Gain
    • Return on Operating Assets
    • Offshore Investments
    • Transfer Price
    • Times Interest Earned Ratio
    • Debt Coverage Ratio
    • Dividend Discount Model
    • Combined Ratio
    • Merger Arbitrage
    • Gordon Growth Model
    • Advantages of Joint Venture
    • Interest Coverage Ratio
    • Reserve Requirements
    • Asset Turnover Ratio
    • Price to Rent Ratio
    • Ratio Analysis Types
    • Debt Ratio
    • Business Risk
    • Financial Leverage
    • Dividend Payout Ratio
    • Mistakes in DCF
    • Risk/Reward Ratio
    • Full Form of FIPB
    • Financial Risk
    • CAPE Ratio
    • Overcapitalization
    • Systematic Risk
    • Hedge Ratio
    • Full Form of NHB
    • Sensitivity Analysis
    • Current Ratio
    • Corporation Examples
    • Asset to Sales Ratio
    • Balance Sheet Ratios
    • List of Financial Ratios
    • Coverage Ratio
    • Forward PE Ratio
    • Interpretation of Debt to Equity Ratio
    • Capitalization Ratio
    • Importance of Ratio Analysis
    • Quick Ratio Interpretation
    • Corporate Finance Basics
    • PEG Ratio
    • Corporate Finance Interview Questions
    • Price to Earnings Ratio
    • Structured Note
    • Limitations of Ratio Analysis
    • NPV vs IRR
    • IRR vs ROI
    • Imputed Interest
    • Full Form of HR
    • Shareholders Agreement
    • Earnings Per Share
    • Corporate Finance Jobs
    • About Corporate Finance
    • Corporate Finance Theory & Practices
    • Career in Corporate Finance
    • Simple Interest Rate vs Compound Interest Rate
    • Stocks vs Shares
    • Bonds vs Debenture
    • Bull Market vs Bear Market
    • Mortgagee vs Mortgagor
    • Horizontal Integration vs Vertical Integration
    • Money Market vs Capital Market
    • Leveraged vs Unleveraged
    • Dividends vs Capital Gains
    • Present Value vs Net Present Value
    • Qualified vs Ordinary Dividends
    • ROE vs ROA
    • Bond vs Loan
    • Stock Dividend vs Stock Split
    • Audit vs Assurance
    • Coupon Rate vs Interest Rate
    • Growth Stock vs Value Stock
  • Accounting fundamentals (658+)
  • Asset Management Tutorial (198+)
  • Banking (44+)
  • Credit Research Fundamentals (6+)
  • Economics (44+)
  • Finance Formula (382+)
  • Financial Modeling in Excel (13+)
  • Investment Banking Basics (120+)
  • Investment Banking Careers (26+)
  • Trading for dummies (67+)
  • valuation basics (27+)
Finance Blog Courses
  • Online Business Valuation Training
  • Equity Research Certification
  • Project Finance Course
Footer
About Us
  • Blog
  • Who is EDUCBA?
  • Sign Up
  • Live Classes
  • Corporate Training
  • Certificate from Top Institutions
  • Contact Us
  • Verifiable Certificate
  • Reviews
  • Terms and Conditions
  • Privacy Policy
  •  
Apps
  • iPhone & iPad
  • Android
Resources
  • Free Courses
  • Investment Banking Jobs Offer
  • Finance Formula
  • All Tutorials
Certification Courses
  • All Courses
  • Financial Analyst All in One Bundle
  • Investment Banking Training
  • Financial Modeling Course
  • Equity Research Course
  • Private Equity Training Course
  • Business Valuation Course
  • Mergers and Acquisitions Course

© 2022 - EDUCBA. ALL RIGHTS RESERVED. THE CERTIFICATION NAMES ARE THE TRADEMARKS OF THEIR RESPECTIVE OWNERS.

EDUCBA
Free Investment Banking Course

Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA
Free Investment Banking Course

Corporate Valuation, Investment Banking, Accounting, CFA Calculator & others

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA Login

Forgot Password?

By signing up, you agree to our Terms of Use and Privacy Policy.

Let’s Get Started

By signing up, you agree to our Terms of Use and Privacy Policy.

EDUCBA

*Please provide your correct email id. Login details for this Free course will be emailed to you

By signing up, you agree to our Terms of Use and Privacy Policy.

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Loading . . .
Quiz
Question:

Answer:

Quiz Result
Total QuestionsCorrect AnswersWrong AnswersPercentage

Explore 1000+ varieties of Mock tests View more

Independence Day Offer - Online Business Valuation Training Learn More