Hi this is Lee Phillips. I want to talk to you two seconds about a terminology
that's used often, called "pass-through".
It's a confusing term because people don't understand that pass-through is a tax term
has nothing to do with the legal entity of the structure.
People will say, "Oh the advantage of an LLC is the LLC is a pass-through entity."
Well, is it really?
A corporation can be a pass-through entity.
Depends upon how the entity, the corporation or the LLC
is going to be taxed.
Now what "pass-through" means is
the owners of the company are taxed on the profit or loss of the company
and the company itself doesn't actually pay a tax.
Yeah, they file a tax return, but the owners get a K-1
and then they're responsible for actually paying tax on their income with the K-1 added in
or the loss.
So if it's not tied to the structure, the legal structure,
then any entity basically can be a pass-through entity.
If you have a sole proprietorship
well, sole proprietorship is one guy
he's taxed on all the income
he puts it on his Schedule C.
He or she uses their social security number
the business itself doesn't get a tax ID number.
Now the advantage of an LLC is
the LLC can choose how it wants to be taxed.
Do the owners want it to be taxed as a sole proprietor?
one owner
actually we call that a "disregarded entity"
the entity is disregarded by the IRS
and they just look at it as if it's a sole proprietorship
they use the social security number of the owner
and he or she puts it on the Schedule C.
Partnership: they get a K-1
and each one of the partners gets a K-1. They pay the tax.
LLC? It gets to choose.
Sole proprietorship/partnership OR taxation under Chapter C of the IRS code OR Subchapter S of the IRS Code.
You've always heard, "Oh I have a C corporation" or "I have an S Corporation"
The corporation, the paperwork, is identical.
The things you have to do to maintain the corporation, the formalities,
in order to get the corporate shield and all that stuff
absolutely identical
whether it's taxed under subchapter S of the IRS code or it's taxed under Chapter C of the IRS code.
If it's a Subchapter S, then it is a pass-through and the owners get the K-1
and they pay the tax.
If it's taxed under Chapter C of the IRS code
Then the company itself pays the tax.
The only way it can get the money, the profit, down to the owners
is to pay a wage or to pay a dividend.
But if it's a dividend, that's a double taxation.
That's another YouTube video.
But it's basically a disaster.
Now the LLC can choose to be taxed
under Chapter C of the IRS code
or Subchapter S of the IRS code
or as a partnership
or as a sole proprietorship disregarded entity.
Corporations can only choose to be taxed
under Subchapter S or Chapter C
So when somebody says, "Oh the advantage of an LLC
is the pass-through entity."
Well, is it?
It may or may not be a pass-through entity.
If you choose to have your LLC taxed under Subchapter C of the IRS code,
it's not a pass-through entity.
So, "pass through," tax term.
It has nothing to do with the legal structure
it just means that the owners pay the tax
of the profit or the loss that comes from the company.
This is Lee Phillips.
Been talking about terminology, "pass through."