Pass-Through Entity
A business entity that does not pay federal income tax at the entity level; instead, profits and losses pass through to owners who report them on their individual returns.
Detailed Explanation
Pass-through entities include S corporations, partnerships, sole proprietorships, and most LLCs. Owners of qualifying pass-throughs may also benefit from the Section 199A Qualified Business Income (QBI) deduction of up to 20%. State-level Pass-Through Entity Tax (PTET) elections are available in many states as a workaround to the SALT deduction cap, allowing the entity to deduct state taxes federally and provide owners a credit on the state return.
Key Points
- Income is taxed once, at the owner level, avoiding C-corp double taxation.
- Includes S corporations, partnerships, sole proprietorships, and most LLCs.
- Owners may claim the Section 199A QBI deduction of up to 20% of qualified business income.
- State PTET elections let the entity deduct state tax federally as a SALT-cap workaround.
- Owners are taxed on their share of profits whether or not the cash is distributed.
Practical Example
A partnership earns $400,000 of qualified business income and pays no federal tax itself. Each owner reports their share, and a below-threshold owner may deduct up to 20% of their QBI under Section 199A, lowering taxable income. If the entity also makes a state PTET election, it can deduct the state tax federally, partially restoring the benefit lost to the SALT cap at the individual level.
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Learn about Business Tax PreparationRelated Terms
S Corporation
A pass-through tax election under Subchapter S of the Internal Revenue Code that avoids corporate double taxation while allowing shareholder-employees to reduce self-employment tax.
Partnership
A business entity owned by two or more persons who share in profits and losses, taxed as a pass-through with each partner reporting their share on their individual return.
Section 199A QBI Deduction
A federal deduction of up to 20% of Qualified Business Income for owners of pass-through entities and sole proprietorships.
Pass-Through Entity Tax (PTET) Election
A state-level tax elected at the entity level to allow pass-through owners to circumvent the federal SALT deduction cap.
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