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
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.
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.
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.
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.