What is a Pass-Through Business?

Pass-throughs are businesses like sole proprietorships, partnerships, S corporations and Limited Liability Companies (LLCs) that pay income taxes under individual income tax rates instead of corporate tax rates.

Specifically, these businesses pass the income to their owners, who then pay individual income taxes on the income.

That is, the business profits “pass-through” to the business owner(s) and show up on their individual IRS 1040 form. There is no income tax at the business level.

Most pass-through businesses are LLCs or S corporations since they provide liability protection and tax savings.

These pass-through businesses are distinct from C corporations which pay tax at the corporate level and the individual. The C corporation files and pays taxes on its own tax return and the business owner files and pays taxes on their own salary and dividends, via a personal tax return.

Under Section 199A of the new tax law (the Tax Cuts and Jobs Act), subject to certain limitations, owners of pass-through businesses are eligible for a 20% deduction of qualified business income.

The 20% deduction is a significant change for small businesses since it was completely unavailable under the previous tax law.

The 20% deduction is a controversial aspect of the tax bill.

Those who support the tax plan claim that the 20% deduction is a huge benefit for small businesses.

Others consider the 20% deduction for pass-through businesses to be a “loophole” which disfavors employed workers and favors the wealthy and those who can afford complex tax advice, since the law pertaining to the 20% deduction of qualified business income is so complex.