Pass-Through Entity
A pass-through entity is a business structure where profits and losses flow through to the owners' personal tax returns rather than being taxed at the business level, including S-Corps, LLCs, partnerships, and sole proprietorships.
Pass-through entities are the most common business structure in the United States, representing roughly 95% of all businesses. Unlike C-Corporations, which pay corporate tax on profits and then shareholders pay tax again on dividends (double taxation), pass-through entities are only taxed once at the owner level.
The "pass-through" label means the business itself does not pay income tax. Instead, profits and losses pass through to the owners' personal tax returns, where they're taxed at individual rates. The business may still file an informational return (Form 1065 for partnerships, Form 1120-S for S-Corps).
Pass-through status is particularly valuable because of the QBI deduction, which allows owners to deduct up to 20% of qualified business income. This effectively lowers the maximum tax rate on pass-through income from 37% to 29.6%.
Losses from pass-through entities can offset other income on the owner's personal return, subject to at-risk rules and passive activity limitations. This loss pass-through is one of the key advantages of the structure for businesses in early stages or those with significant depreciation deductions.
Choosing between pass-through and C-Corp taxation depends on your income level, growth plans, and reinvestment strategy. Businesses that retain significant earnings for growth may benefit from C-Corp's 21% flat rate, while owners who distribute most profits typically prefer pass-through treatment.
Practical Example
A partnership with two equal partners earns $400,000 in profit. The partnership pays no tax. Each partner reports $200,000 on their personal return and pays tax at their individual rate. With the QBI deduction, each partner deducts $40,000, reducing their taxable business income to $160,000.