Pass-Through Entity
A business entity that generally does not pay federal income tax at the entity level. Income, deductions, gains, losses, and credits "pass through" to the owners, who report their distributive shares on their individual tax returns. Includes partnerships, LLCs taxed as partnerships, S-corporations, and disregarded single-member LLCs.
A pass-through entity (also called a flow-through entity) is a business entity that generally does not pay federal income tax at the entity level. Instead, the entity's income, deductions, gains, losses, and credits "pass through" to the owners, who report their distributive shares on their individual income tax returns. The principal pass-through entity types are general and limited partnerships, LLCs taxed as partnerships (the default for multi-member LLCs), S-corporations, and disregarded single-member LLCs.
Pass-through types compared
The principal pass-through structures: (1) General partnership, default treatment for two or more persons carrying on a business for profit; files an annual Form 1065 return but pays no entity-level income tax; flexible allocations; unlimited liability for partners unless the partnership registers as a limited liability partnership. (2) Limited partnership, pass-through with limited liability for limited partners and at least one general partner, who has unlimited liability unless the partnership registers as a limited liability partnership. (3) LLC taxed as partnership, most common modern structure; combines limited liability with partnership flow-through. (4) S-corporation, pass-through corporation with strict eligibility rules (100-shareholder cap, single class of stock, shareholders limited to individuals who are not nonresident aliens, plus estates, certain trusts and certain tax-exempt organizations). (5) Disregarded entity, single-member LLC; treated as part of owner for federal tax purposes; activity reported on owner's Schedule C, E, or 1120 depending on owner type.
Distributive share vs. distribution
A critical pass-through concept: the owner's tax obligation is based on the entity's allocated share of income (the "distributive share" reported on the K-1), not on cash distributed. If an LLC taxed as a partnership reports $400,000 of income and allocates 25% of it to a member, that member is taxed on $100,000, regardless of whether the LLC distributed any cash. This mismatch creates phantom income and is the principal driver of tax-distribution provisions in operating agreements. See Phantom Income.
Section 199A, the QBI deduction
Pass-through owners may qualify for the Qualified Business Income deduction under § 199A (20% deduction on qualified business income). Pub. L. 119-21, enacted July 4, 2025, repealed the deduction's scheduled expiration after 2025, so it continues for later tax years. Above income thresholds, the deduction is subject to wage and qualified property limits and is reduced or eliminated for "specified service trade or business" activities (law, health, accounting, financial services, consulting, athletics, performing arts).
The 2017 reduction of the C-corp rate to 21% combined with Section 1202 has reopened the structural question for some founders, particularly those building toward an exit or seeking institutional financing. The right answer depends on (1) financing plans; (2) ownership profile; (3) distribution vs. retention strategy; (4) state-tax exposure across multiple jurisdictions; (5) exit horizon.