What Is Pass-Through Entity Taxation and How Can It Save You Money on Taxes?
Your business structure might be quietly costing you thousands in self-employment tax. Here’s exactly how pass-through taxation works and when electing S Corp status can put serious money back in your pocket.
Summary of What This Blog Covers
- How pass-through income flows to your personal return
- Why S Corp status can cut self-employment tax dramatically
- The IRS “reasonable salary” rule explained
- When to stay LLC vs. elect S Corp (and when C Corp wins)
What Is a Pass-Through Entity?
Profit flows straight to your personal 1040 — no corporate-level tax. Common types: Sole prop, LLC (default), Partnership, S Corp.
Pass-Through ≠ Tax-Free
As a sole prop or default LLC you pay full 15.3% self-employment tax on all profit. Example: $150k profit → ~$23k self-employment tax before income tax.
The S Corp Advantage
Split income into W-2 salary (subject to payroll tax) and distributions (no self-employment tax). Often saves $10k–$30k+ per year for owners above ~$60k profit.
Reasonable Salary Rules (The Catch)
IRS requires you pay yourself market-rate salary before taking distributions. Too low = audit risk. We use industry benchmarks + your actual duties to set it right.
When S Corp Makes Sense
Consistently >$60k net profit • Want to pull money out personally • Can handle light payroll compliance. Below that, LLC usually wins on simplicity.
Why Some Still Choose C Corp
Reinvesting heavily • Raising VC • Stock options • Planning an eventual sale. Otherwise, pass-through + S election usually beats C Corp for owner payouts.
Ready to see if you’re leaving money on the table?
Book an Entity Structure Review with Insogna. We’ll run your numbers side-by-side (LLC vs. S Corp vs. C Corp), show you the exact savings, and handle the election paperwork. Whether you searched “CPA Austin”, “tax advisor near me”, or “small business CPA”, we’ve got you covered.
Frequently Asked Questions
1) How does pass-through taxation actually work?
Business profit flows to your personal return via Schedule K-1 or Schedule C. No corporate tax — but you still pay income + self-employment tax (unless you’re an S Corp).
2) Why do people say S Corps save money on taxes?
Distributions escape the 15.3% self-employment tax. Real savings when done with proper reasonable salary.
3) How do I know if S Corp is right for me?
Usually yes above ~$60k consistent profit. We run a free side-by-side projection so you see the exact savings before deciding.
4) What’s a “reasonable salary”?
Market rate for your role + duties. We use industry data + documentation so you’re audit-protected and still maximize savings.
5) Why do some businesses choose C Corp instead?
Heavy reinvestment, VC funding, stock options, or sale plans. For most owners taking money home, pass-through + S Corp wins.