Pass-through taxation explained

Most small businesses in the US are pass-through businesses, which is why the phrase comes up constantly. This guide explains what it means in practice, including the part that surprises new owners: tax on profit you have not taken out.

By Muhammad Bilal, Chartered Accountant. Reviewed by Awais Jameel, Chartered Accountant. Checked against official sources on . 2 minute read.

Short answer

Pass-through taxation means a business pays no federal income tax itself. Its profit passes through to the owners, who report it on their own returns and pay tax at their own rates. Sole proprietorships, partnerships, most LLCs and S corporations are taxed this way. Owners are taxed on their share of profit even if the business keeps the money.

At a glance

Tax at business level
None, federally, in most cases
Who pays
The owners, on their personal returns
Pass-through businesses
Sole proprietorships, partnerships, most LLCs, S corporations
Taxed on
Each owner's share of profit, distributed or not
Owner reporting
Schedule C, or a Schedule K-1 from the business
Alternative
C corporation: taxed at 21%, then again on dividends
Pass-through taxation explainedTax at business level: None, federally, in most cases; Who pays: The owners, on their personal returns; Pass-through businesses: Sole proprietorships, partnerships, most LLCs, S corporations; Taxed on: Each owner's share of profit, distributed or not; Owner reporting: Schedule C, or a Schedule K-1 from the business; Alternative: C corporation: taxed at 21%, then again on dividends.KEY FACTS AT A GLANCEPass-through taxation explainedTax at business levelNone, federally, in mostcasesWho paysThe owners, on theirpersonal returnsPass-through businessesSole proprietorships,partnerships, most LLCs,S corporationsTaxed onEach owner's share ofprofit, distributed ornotOwner reportingSchedule C, or a ScheduleK-1 from the businessAlternativeC corporation: taxed at21%, then again ondividendsChecked against official sourcesTax BakersPass-through taxation explainedTax at business level: None, federally, in most cases; Who pays: The owners, on their personal returns; Pass-through businesses: Sole proprietorships, partnerships, most LLCs, S corporations; Taxed on: Each owner's share of profit, distributed or not; Owner reporting: Schedule C, or a Schedule K-1 from the business; Alternative: C corporation: taxed at 21%, then again on dividends.KEY FACTS AT A GLANCEPass-through taxation explainedTax at business levelNone, federally, in most casesWho paysThe owners, on their personal returnsPass-through businessesSole proprietorships, partnerships, mostLLCs, S corporationsTaxed onEach owner's share of profit, distributed ornotOwner reportingSchedule C, or a Schedule K-1 from thebusinessAlternativeC corporation: taxed at 21%, then again ondividendsChecked against official sourcesTax Bakers
Key facts at a glance, as set out in this guide.

What does pass-through mean?

The business's income, deductions and credits pass through to the owners. The business works out its profit, but the tax is paid by the owners on their own returns. The profit is taxed once, at the owners' rates.

BusinessHow profit reaches the owner's return
Sole proprietorship or single-member LLCDirectly on Schedule C. See Schedule C
Partnership or multi-member LLCForm 1065, then a Schedule K-1 to each partner. See Form 1065
S corporation, or LLC taxed as oneForm 1120-S, then a Schedule K-1 to each shareholder. See Form 1120-S

Why are owners taxed on profit they did not take?

Because the tax follows the profit, not the cash. If a two-partner business earns $200,000 and keeps it all to buy stock, each partner is still taxed on $100,000 that year. When the money is later paid out, it is generally not taxed again, up to the owner's basis. Many businesses make tax distributions so owners can pay the bill. See how to pay yourself from an LLC.

How does it compare with a C corporation?

Pass-throughC corporation
Tax on profitOnce, at the owners' rates21% at the company, then again on dividends
LossesCan offset owners' other income, within limitsStay in the company
Retained profitTaxed to owners each yearTaxed only at 21% until paid out
Deduction for ownersQualified business income deduction may applyNone

See how LLCs are taxed for choosing between them.

What other taxes apply to pass-through income?

  • Self-employment tax on profit of sole proprietors and active partners. See self-employment tax explained.
  • State taxes, and in some states taxes or fees on the business itself, such as California's $800 minimum.
  • The qualified business income deduction reduces the tax, generally by up to 20% of qualified profit. See the QBI deduction explained.

What about foreign owners?

Pass-through treatment applies to foreign owners too. The question is then whether their share of profit is taxable in the US, which depends on whether it is effectively connected with a US business. See effectively connected income explained.

Not sure how your business is taxed?

We confirm your business's tax status, prepare its returns and the owners' returns, and plan tax payments around the profit that passes through.

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Questions people ask

What is pass-through taxation?

A tax treatment where the business pays no federal income tax and its profit is taxed on the owners' personal returns.

Which businesses are pass-through entities?

Sole proprietorships, partnerships, most LLCs and S corporations.

Do I pay tax on pass-through profit I did not withdraw?

Yes. Owners are taxed on their share of profit whether or not it was distributed.

Is an LLC a pass-through entity?

By default, yes. An LLC can elect to be taxed as a C corporation instead.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IRS Publication 541: Partnerships
  2. IRS Publication 334: Tax Guide for Small Business
  3. Internal Revenue Code section 1366: pass-through of S corporation items
  4. IRS: Instructions for Form 1065 (2025)

Rules and fees change. If you are reading this long after September 30, 2026, confirm the figures with the source before you rely on them.

Business tax by entity typeHow LLCs are taxed: the four optionsBusiness tax by entity typeThe qualified business income deduction explainedFederal tax formsSchedule K-1 (Form 1065) explained

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This guide is general information. It is not tax or legal advice for your situation.