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Pass-through taxation is when a business entity (like a Limited Liability Company) doesn’t pay taxes on business profits directly to the IRS. Instead, the tax-paying responsibility “passes through” to the owners.
Pass-through taxation is one reason people choose to form LLCs. An LLC is a pass-through business entity and it avoids double taxation.
Tip: It may be easier to think of pass-through taxation as “flow-through” taxation. Meaning, the tax-paying responsibility “flows through” to the LLC owner(s).
LLCs that are treated as Pass-through Entities include:
- LLC taxed as a Sole Proprietorship
- LLC taxed as a Partnership
- LLC taxed as an S-Corporation
- LLC taxed as a Qualified Joint Venture (community property states)
Only one type of LLC is not treated as a Pass-through Entity: an LLC taxed as a C-Corporation. In this case, the LLC pays corporate taxes on the LLC’s profits. And the owners pay personal income tax on their dividends using their personal tax returns. This is referred to as “double taxation”.
Does my LLC have pass-through taxation?
| Tax classification | Pass-through taxation? |
|---|---|
| LLC taxed as Sole Proprietorship | Yes, taxes flow through to the owner |
| LLC taxed as Partnership | Yes, taxes flow through to the owners |
| LLC taxed as S-Corp | Yes, taxes flow through to the owner(s) |
| LLC taxed as C-Corp | No, the LLC pays corporate income tax |
What are the benefits of pass-through taxation?
The benefit of pass-through taxation is avoiding double taxation.
Double taxation is when profits are taxed twice (once at the entity-level and again at the personal level).
In contrast, pass-through entities are only taxed once – at the personal level.
LLC Pass-through Taxation FAQs
What’s the LLC pass-through tax rate?
For pass-through entities, the amount of tax you pay doesn’t change. It’s the same amount as if you were operating without an LLC.
Meaning, the business income from your LLC “flows through” to your personal tax return. And then your income tax is based on the graduated rates set by the IRS, plus any flat-rate taxes like self employment tax. Check your personal income tax rate here: IRS Income Tax Rates for 2021.
Note: An LLC taxed as a C-Corporation pays entity-level taxes at the corporate tax rate. And the owners also pay personal income tax at their personal income tax rate. You can determine your corporate tax rate here: IRS: Publication 542.
What do I need to do to get pass-through taxation?
You don’t need to do anything special for your LLC to be treated as a pass-through entity. This is the default tax classification for all Single-Member LLCs and Multi-Member LLCs.
An LLC is assigned this default tax classification by the IRS when you apply for your EIN.
Does having an LLC help with taxes?
No, having an LLC doesn’t help you save money on business income taxes.
(The main reason people form an LLC is for personal asset protection, not tax liability purposes.)
With LLCs taxed in their default status, you pay the same amount of taxes as you would operating a business without an LLC.
Said another way, an LLC pays the same amount of taxes as if you were operating as a Sole Proprietorship (or General Partnership).
Exception (choose an elective status):
For businesses with established revenue, requesting your LLC be taxed as an S-Corporation can save money on self-employment tax. However, it costs money to run an S-Corporation, so we recommend looking into this once your business is making about $70,000 net income annually, per Member. See LLC Taxed as S-Corp for more information.
When does it make sense for my LLC to be taxed as a C-Corporation?
This is not a common election and we don’t recommend this for most people.
However, if your LLC has lots of employees, then electing C-Corporation tax treatment can save your business money on health care fringe benefits.
If you are considering an LLC taxed as a C-Corporation, we recommend speaking with an accountant.
Matt holds a Bachelor's Degree in business from Drexel University with a concentration in business law. He performs extensive research and analysis to convert state laws into simple instructions anyone can follow to form their LLC - all for free! Read more about Matt Horwitz and LLC University.
Hi Matt, is the below example an accurate representation of pass-through taxation?
LLC Owner’s primary annual salary (another job): $120k
LLC Owner’s LLC annual net income: $50k
Before creating the LLC, the LLC Owner’s marginal tax rate was 24%
With the LLC pass-through taxation, the LLC Owner’s marginal tax rate is 32%
I want to confirm if pass-through taxation is added to your existing income and has the possibility to put you in another tax bracket.
If I have a LLC taxed as S-corp.
The LLC member is a S-corp.
What do I (pass thru) to the member S corp. for its books? a k-1?
Thanks
I’m not asking for the legal advise, just idea where/how
Hi Mark (in the eyes of the IRS), when an S-Corp owns and S-Corp this is called a Qualified Subchapter S Subsidiary (QSSS). We’re not a tax firm, so can’t answer how you should complete your returns. We recommend speaking to an accountant or two.
We have a pass-through LLC established in MAssachusetts in 2014. It is based out of our house. We have expanded to a store-front location. We have 2 managers and our net income from the LLC is <$50,000.00 per year. Should we consider changing the tax status type to an S-corp? How difficult is that? Massachusetts is one of the states that allow conversion.
Hi Mark, the “conversion” would actually take place at the federal level with the IRS. In this situation, I personally wouldn’t do it. Setting up and maintaining an LLC/S-Corp is a lot of work. And can be stressful and cause headaches. Furthermore, I personally don’t recommend looking into it until there is at least $70,000 of net income per LLC Member. Hope that helps.