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Simple English definitions for legal terms
Pass-through taxation
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A quick definition of Pass-through taxation:
Pass-through taxation is when a business doesn't pay taxes on its own income. Instead, the money goes to the owners of the business, who pay taxes on their personal income. This usually applies to small businesses like sole proprietorships, partnerships, and S-corporations. It's different from big companies that pay taxes on their income and then the owners pay taxes again on their personal income. Some states have their own rules for pass-through taxation. Owners of pass-through businesses may be able to choose to be taxed like a big company, but there are some benefits to pass-through taxation, like a tax deduction that can lower the amount of income the owners have to report on their taxes.
A more thorough explanation:
Pass-through taxation is a way of taxing businesses where the income earned by the business is not taxed at the entity level. Instead, the income is passed through to the owners of the business who pay personal income taxes on their share of the business. This type of taxation is usually applied to sole proprietorships, partnerships, and S-corporations.
For example, let's say you and your friend start a small business together. If your business is eligible for pass-through taxation, the income earned by the business will be passed through to you and your friend. You will both pay personal income taxes on your share of the income earned by the business.
Pass-through taxation is different from traditional corporations or C-corporations, where the company itself pays corporate taxes on the income earned by the corporation. The owners of the corporation are then taxed on the income they receive from the corporation, either through the sale of stock or distributions.
It's important to note that some states may have different regulations for pass-through taxation. In some cases, an entity that is eligible for pass-through taxation may choose to be taxed as a corporation instead.
One benefit of pass-through taxation is the Qualified Business Income Tax Deduction, which reduces the income that owners of a pass-through business must report on their personal income taxes by up to 20% if they qualify.