Tax time can get overwhelming, especially if you’re a self-employed individual trying to figure out how your business fits into the tax system. But good news to all self-employed individuals—such as independent contractors, locum tenens, CRNAs, freelancers, gig workers, and small business owners—filing and paying taxes is easier and simpler than you think once you understand the principle of pass-through entities. 

What is a Pass-through Entity? 

A pass-through (or flow-through) entity is a business structure that passes its income directly to its owners or shareholders. Simply stated, it is a type of business that does not pay income tax of its own. Instead, the business’s income or losses passes or flows through its owners’ income tax returns where it is then taxed at the personal income tax bracket of the owners. 

The owners of these pass-through entities are responsible for paying its taxes as part of their personal income. 

Avoiding Double Taxation with Pass-through Entities 

Traditional corporations (C corporation) go through two layers of taxation: (1) the business pays corporate income tax, and then (2) shareholders pay taxes again on dividends they receive. Pass-through entities help self-employed individuals avoid this double taxation! Instead of being taxed twice for the same earnings, their business’ income passes directly to the owners’ tax return and is only taxed once. 

Business Structures that Qualify as Pass-through Entities 

• Sole proprietorships  

• Limited liability companies (LLCs) 

• General partnerships  

• Limited partnerships  

• Limited liability partnerships  

• S corporation 

What is a Disregarded Entity? 

The tax term “disregarded entity” is an IRS classification for a business structure that is legally separate from owner but not separate for federal tax purposes. They do not file a separate tax return and its income or losses directly pass through its owner’s personal tax return. These entities are “disregarded” or “ignored” for tax purposes. 

The most common disregarded entity are the single member LLCs. In fact, they are automatically classified as a disregarded entity unless they elect to be treated as a corporation. An LLC is often preferred by self-employed individuals because of its simplified taxation as a pass-through entity while providing limited liability protection to its owner (separating personal assets from business debts and lawsuits). 

A multi-member LLC is not a disregarded entity, but a married couple who co-owns an LLC may be classified as a disregarded entity if the following conditions are met: 

• The LLC is fully owned by each spouse as community property under state law 

• No other owners are reported on federal tax returns 

• The LLC is not treated as a corporation under federal law 

Other business structures that are disregarded entities are: a qualified subchapter S subsidiary and a qualified real estate investment trust (REIT) subsidiary. 

Disregarded Entities vs Pass-through Entities 

All disregarded entities are pass through entities, but not all pass-through entities are disregarded entities.  

S Corporations and partnerships are pass-through entities but are not disregarded entities because they file their own separate returns (Forms 1120-S and 1065, respectively). 

Sole proprietorships are also not classified as a disregarded entity since it has no separate legal entity from its owners to begin with. Unlike an LLC, which is a legally distinct entity that can be “disregarded” for tax purposes. 

Want to learn more?  

You may want to consult and work with 1099 Accountant – We offer online bookkeeping, online advisory services and online tax and accounting services. We offer reasonable rates. We only work with independent contractors, freelancers, and one-person business. We work with locum tenens from California to New York City and everywhere in between. Yes, even Hawaii!  

Contact us toll-free (855)529-1099 or make an appointment for a free consultation. Contact Us