Pass-Through Entity
A business entity that 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 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; no entity-level filing; flexible allocations; unlimited liability for partners. (2) Limited partnership, pass-through with limited liability for limited partners but at least one general partner with unlimited liability. (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, U.S. individuals/certain trusts only). (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. An LLC member owning 25% of a partnership reporting $400,000 of income 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), which expires for tax years beginning after December 31, 2025 unless extended. The deduction is subject to wage and qualified property limits, with reduced benefits for "specified service trade or business" activities (law, health, accounting, financial services, consulting, athletics, performing arts) above income thresholds. Taxpayers and entities should monitor 2025-2026 legislation for extension or modification.
Pass-through structure has been the default choice for closely-held Texas businesses for decades. 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. The decision should be made deliberately and revisited at each major corporate event.