Blog No 148

June 7, 2022

By Mack W. Borgen

Author (7 Books): The White Binder (2022); The Writings of a Lifetime (2021); Dead Serious and Lighthearted – The Memorable Words of Modern America (Three Volumes) (2018-2019); and The Relevance of Reason – The Hard Facts and Real Data about the State of Current America (2 Volumes) (2013). As Advertised in The New York Review of Books. Recipient of Eight National Book Awards

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“Pass-Through Entities” in a Nutshell

When people begin a business, they should not be required to expose all of their personal and familial assets to potential business liability claims. This is one of the primary reasons for forming and then conducting business through the use of entities.

For small and moderate-sized businesses which do not need to raise large capital through the use of, for example, public offerings, the use of “pass-through” entities is one way to more safely conduct one’s business. Pass-through entities are so named because they also provide income tax advantages to the business owners because no taxes are paid at the entity level. Full separate business tax returns do not need to be prepared. Instead, the businesses’ taxable income is reported only on and via the owner’s (or owners’) individual tax returns.

A sole proprietor reports his or her income on a Schedule C to their individual tax return. Other entities such as partnerships and S corporations send their owners annual K-1 tax reporting forms ratably based upon such owner’s share in the profits and losses of the business.

These types of entities are referred to as “pass-through” entities because the owners of such “pass-through” partnership or S corporations (as opposed to, for example, standard C corporations) use them to avoid the imposition of double-taxation – first, at the corporate level, and then again at their personal 1040 tax reporting level.

The popularity of pass-through entities is evidenced by their numbers. Based upon the IRS data (2017), there are roughly three times as many S Corporations (roughly 4.72MM) as there are C corporations. However, since their introduction in the early 1990s, limited liability corporations (“LLCs) are becoming even more popular, and today there are more than 11.0MM such LLC entities.

In California, the annual $800 minimum franchise fee cannot be avoided excepting for (at least through 2023) part or all of the entities’ year of formation. However, this is a small amount to pay in order to minimize one’s personal liability for taxes at both the business level and again at the personal level.

CLOSING NOTE AND ADVISORY CAUTION: It is beyond the scope of this article, but this author normally advises individuals to meet with their insurance advisors during their business formation stage and to seriously consider purchasing some form(s) of general liability policies. Such policies can be surprisingly inexpensive, and (especially in today’s litigious world) the “duty to defend” features of such insurance can sometimes be as valuable as their liability protections.

Part of the above brief article is based upon Bryars Tolleson Spires Whitton, LLP brief article entitled “Understanding Tax Terms: Pass-through Entities (June 2022).

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New Term – The Rise of the “Triple Peak Day”

Historically, the workday has been oftentimes defined as the 9-to-5 workday. However, in an age of remote and hybrid work and with the growing acceptance of work-hours flexibility, the periods of actual and even expected work productivity have changed.

Data has long suggested highest productivity before lunch and after lunch. Now, however, “a third peak (has) emerged for some in the hours before bedtime.” This phenomenon has created what is being frequently referred to as a “triple peak day.” Source: “The Rise of the Triple Peak Day” by Microsoft / Worklab.

The Critical Teaching of Financial Literacy

Money is one of the most-discussed topics between parents and teens. While it is reported that 93% of teens believe financial knowledge is crucial to their achieving their life goals, most 15-to-18-year-old fail basic financial literacy tests.

Arguably, the best — and most thorough — teaching will come from parents and grandparents, but our schools have an important role as well. Finally, some progress is being made.

In 2021, one-half of US states proposed bills requiring personal finance courses to be made a part of high school curricula, and in March, Florida became the largest state to mandate the taking of such class in order to graduate. This year, a record 25% of US high school students are expected to take a personal finance course before graduation – up from 20% last year. And that is good.

April was Financial Literacy Month. Yea, there’s a month for that too. But financial literacy is critically important. You will find below the dozen financial concepts which each of us — and our schools — should assure that children and students and young adults understand.

1. Bank Accounts. How bank accounts work (basics of tracking and reconciling bank activity).
2. Credit cards. How credit cards work (exorbitant interest rates and how credit cards create de facto loans).
3. Tax Basics including the “reading” of one’s pay stub, the basic understanding of Social Security and Medicare taxes, and the automatic deductions and federal and state tax withholdings.
4. Retirement Accounts including the advantages of long-term savings tools such as IRAs.
5. Credit Scores. The use, importance and factors affecting credit scores.
6. Spending within Means. Importance of saving before spending and the mere importance of tracking one’s savings habits.
7. The Art and Tools of Saving including savings habits and mechanisms such as separate savings accounts or even the use of automatic paycheck transfers.
8. The Strength of the Less Obvious Forms of Investment such as in oneself in manners such as by dedication, education, or sheer hard work.
9. Stocks and Mutual Funds. The basic short-term risks and possible long-term advantages of investing in stocks, bonds, and mutual funds and the tracking of stocks via, for example, Dow Jones, S&P, and NASDEQ.
10. Budgeting. Methodologies of creating a budget and tracking income, spending, and savings.
11. The Importance and Meaning of Cash Flow including the differences between asset/wealth growth and timing effects of cash flow.
12. Calculation of Net Worth. The basic presentation and calculation of one’s net worth including assets and liabilities (including contingent liabilities).

Sources: (1) Bryars Tolleson Spires Whitton, LLP., and (2) Robinhood Snacks – Digestive Financial News (April 4, 2022). My special thanks to and recognition of my friend, Mr. Robert Badal of Santa Barbara, California for his long-time efforts in furtherance of encouraging California public school to teach financial literacy.

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