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What Is Pass-Through Tax?

  • Learn
  • February 15, 2016 | Katherine Gustafson

Pass-through tax is a type of tax that one party collects and remits to another party without taking any of the money.

There are many types of pass-through tax. One common arrangement is one in which business owners pay taxes on their business profits via their individual tax returns, as in a sole proprietorships.

In that case, the income from the business activities "passes through" the owners' personal financial accounting to reach the appropriate government authorities. The owners don’t get to keep any of those taxes, even though they’re personally reporting and remitting the money owed by the business entity. (In the case of a sole proprietorship, the business entity and the person are the same thing, which makes all of this a confusingly academic argument, but hey, we’re talking about taxes here -- of course nothing could be simple!)

Sales tax is a type of pass-through tax. The tax “passes through the sellers’ coffers, from the customer to the government agency that requires it, without the middle-man (the seller) taking any off the top. The amount collected from the buyer equals the amount remitted to the taxman.

For business owners, handling a pass-through tax requires a lot of work and offers little -- if any -- reward. Even though the consumer is responsible for paying the tax, the seller is usually the one obligated to collect it. In an audit, a seller is the one liable for the whereabouts of the tax.

The idea of sales tax passing through your business means that “paying” your sales taxes is a misnomer. Ideally you’re not incorporating the sales tax you collect into your own accounts and then reaching into your own pocket to pay the tax collector out of funds that are indistinguishable from your profits or operating expenses.

The correct way to deal with sales tax, on the other hand, is to think of it as exactly what it is -- something that simply passes through your business without leaving a trace. You should keep the tax money you collect separate from your other funds so that when you remit it to the state taxing authorities you’re really just handing over someone else's funds that you’ve been babysitting, not paying what you consider to be your own money.

Because the sales tax money is never yours. Treat it as such and you’ll be a much happier businessperson.

Avalara Author
Katherine Gustafson
Avalara Author Katherine Gustafson