What Are Pass Through Entities?

Clients Rate Lawyers on our Platform 4.9/5 Stars
based on 4,036 reviews

Jump to Section

Need help with a legal contract?

Post Project Now

Post Your Project (It's Free)

Get Bids to Compare

 Hire Your Lawyer

What Are Pass-Through Entities?

Pass-through entities are businesses that aren't subject to corporate income taxes. Also known as a flow-through entity or a pass-thru entity, this type of business structure allows profits to go directly to the owners or members who pay individual income taxes on any revenue. These businesses effectively avoid double taxation, or taxing both corporate income and individual income.

In 48 states, pass-through entities account for the majority of the private-sector workforce, according to the Tax Foundation. These businesses also account for about 40% of private-sector payroll. Pass-through entities are particularly common in the service industry, where they're responsible for over 70% of employment in arts, entertainment, and food service and 60% of employment in utilities, construction, transportation, information, education, and health care.

How Do Taxes Work for a Pass-Through Entity?

Although the pass-through entity definition states that these companies don't pay income taxes, they often have to file federal tax returns. These returns state the company's income and indicate how it flows through to the company's partners. Then each partner files a Schedule C, Schedule E, or Schedule K-1 to report their income from the business and pay the associated income taxes.

Since 1980, the increase in pass-through entities has contributed to a substantial decrease in corporate revenues , according to the Brookings Institute. If 1980 corporate tax levels remained in place today, business taxes would have generated about $100 billion per year.

From 2017 on, most pass-through entities have received additional tax breaks due to the Tax Cuts and Jobs Act. This act lets business owners and partners deduct 23% of their income , decreasing their individual rate and leading to savings. Because most individuals who claim pass-through income are high earners, these tax reforms offer significant savings for business owners. The top 1% of earners receive about 70% of partnership income, according to the Brookings Institute.

Do State Income Taxes Allow Pass-Through Income?

Although most states follow federal taxation rules for pass-through entities, some view these businesses differently. Connecticut, Louisiana, Oklahoma, Rhode Island, and Wisconsin all charge these companies at the entity level. To avoid double taxation, they give the company's partners a tax credit to apply to their individual income tax return.

No matter where you do business, it's important to confirm business structure and taxation rules before filing your return. Pay close attention to state tax reforms, as the current rules may change with limited notice.

How Do You Know If Your Company Is a Pass-Through Entity?

The vast majority of businesses in the United States are pass-through entities. That means there's a good chance that yours is, too. When you start a new business, it's automatically categorized as a sole proprietorship or a partnership and considered a pass-through entity. It ceases being a flow-through entity only if you incorporate and choose to be taxed as a C-corporation.

Flow-through entities have contributed an increasing share of business activity since 1986, according to the Tax Policy Center. Today, they represent over 50% of the total net income for businesses in the U.S.


Get Free Bids to Compare

Leverage our network of lawyers, request free bids, and find the right lawyer for the job.

Get Bids Now

Types of Pass-Through Entities

To define pass-through entity, it's helpful to understand the many types of businesses that use this structure. Because so many business structures serve as flow-through entities, it's easy to choose one of these options to minimize your corporate tax burden:

  • Sole proprietorship: Unlike other flow-through entities, businesses with single owners don't have to file separate income tax forms. Instead, the owner reports relevant income on Schedule C of their individual tax return. If you have a sole proprietorship, your net income may also be subject to payroll taxes.
  • Partnership: Both general and limited partnerships have one or more owners and file a Form 1065 to report entity-level revenue. Each owner has to report their share of this revenue on Schedule E of their individual tax return. General partners typically have to pay payroll tax on their net income, but limited partners owe this tax on guaranteed payments only.
  • Limited liability company (LLC): Whether you run a single- or multiple-member LLC, you have a few taxation options. You can choose for your business to be taxed as a partnership, which requires filing an entity-level Form 1065 and an individual Schedule E. Alternatively, you can choose for your company to be taxed as a corporation, which means your business is not considered a pass-through entity.
  • S-corporation: With this business structure, your company gains pass-through corporation status. As an S-corporation, you have to file an entity-level Form 1120S, which allows profits to flow to shareholders, who report their income on an individual Schedule E. As a pass-through corporation, this type of business is subject to some additional restrictions. S-corporation owners have to receive reasonable compensation, on which they owe Federal Insurance Contributions Act (FICA) taxes.

In most cases , flow-through entities are smaller than C-corporations. However, not all pass-through entities are small businesses, according to the Tax Foundation. Altogether, about 72% of these entities have fewer than 100 employees, about 34% of which reflect self-employment. The remaining 28% includes companies with over 100 employees, and 16% of them are big businesses with over 500 employees.

Pros of Pass-Through Entities

If you're considering setting up a flow-through business, you could experience some significant perks. Some of the biggest benefits of this business structure include:

  • Single taxation: Pass-through entities avoid double taxation by levying taxes on individuals only. As a result, the business and its owners or members can recover significant savings.
  • Increased tax deductions: Tax reforms allow pass-through entities to deduct up to 20% of their income. These deductions can also lead to substantial savings.
  • Opportunities for deductible losses: If pass-through entities incur losses, they flow through to the individual. Business owners can deduct these losses and reduce their own personal liabilities.
  • More equitable taxation: For flow-through entities, all corporate income passes to the owners or members. Those in higher tax brackets naturally pay a higher percentage, which contributes to a more equitable burden.
  • Straightforward setup: In addition to the many tax-related benefits, owners of pass-through entities also have an easier time setting up their businesses. Unlike C-corporations, which can be highly complex, sole proprietorships and partnerships require minimal paperwork and fees.

Cons of Pass-Through Entities

Although flow-through entities offer a wide range of benefits, they also have some potential drawbacks. Some of the most common downsides of pass-through entities include:

  • Higher tax rates: Since 2018, the corporate tax rate has hovered around 20%, while the individual tax rate can be much higher, depending on income brackets. If your income flows through an LLC or a partnership, you could pay much higher tax rates.
  • Fringe benefit taxes: C-corporations can deduct the cost of fringe benefits, while their employees don't have to pay taxes on them at all. In contrast, pass-through entities generally do.
  • Taxes on income not received: Because all income from pass-through entities flows to the business partners, even if they didn't receive it, they may pay tax on income they didn't get yet. In contrast, C-corporations often have the ability to defer paying taxes on their share.
  • Limitations on stocks: S-corporations benefit from a corporate structure and pass-through entity status, yet they face severe limitations on stocks. They can have no more than 100 shareholders, and they can only issue one type of stock. As a result, they may struggle to raise funds.

Whether you need advice on your business structure or you need assistance with your corporate filing, the ContractsCounsel team is here to help. Get a free proposal and take the first step toward forming your business today.

How ContractsCounsel Works
Hiring a lawyer on ContractsCounsel is easy, transparent and affordable.
1. Post a Free Project
Complete our 4-step process to provide info on what you need done.
2. Get Bids to Review
Receive flat-fee bids from lawyers in our marketplace to compare.
3. Start Your Project
Securely pay to start working with the lawyer you select.

Meet some of our Lawyers

Dean F. on ContractsCounsel
View Dean
5.0 (4)
Member Since:
November 18, 2022

Dean F.

Managing Attorney
Free Consultation
Get Free Proposal
Castle Rock, CO
27 Yrs Experience
Licensed in CA, CO, TN
University of Mississippi School of Law

Ferraro Law Firm was founded by Dean C. Ferraro. Dean earned his Bachelor's Degree from California State Polytechnic University, Pomona ("Cal Poly Pomona") in 1992 and his J.D. Degree from the University of Mississippi School of Law ("Ole Miss") in 1996. He is licensed to practice law in the State Courts of Colorado, Tennessee, and California. Dean is also admitted to practice before the United States District Courts of Colorado (District of Colorado), California (Central District), and Tennessee (Eastern District). Shortly after earning his law license and working for a private law firm, Dean joined the District Attorney's office, where he worked for five successful years as one of the leading prosecuting attorneys in the State of Tennessee. After seven years of practicing law in Tennessee, Dean moved back to his birth state and practiced law in California from 2003-2015. In 2015, Dean moved with his family to Colorado, practicing law in beautiful Castle Rock, where he is recognized as a highly-effective attorney, well-versed in many areas of law. Dean's career has entailed practicing multiple areas of law, including civil litigation with a large law firm, prosecuting criminal cases as an Assistant District Attorney, In-House Counsel for Safeco Insurance, and as the founding member of an online law group that helped thousands of people get affordable legal services. Pursuing his passion for helping others, Dean now utilizes his legal and entrepreneurial experience to help his clients in their personal and business lives. Dean is also a bestselling author of two legal thrillers, Murder in Santa Barbara and Murder in Vail. He currently is working on his next legal thriller, The Grove Conspiracy, set to be published in 2023.

Jason P. on ContractsCounsel
View Jason
5.0 (2)
Member Since:
December 1, 2022

Jason P.

Business Lawyer
Free Consultation
Get Free Proposal
Portland, OR
7 Yrs Experience
Licensed in OR, WA
Lewis & Clark Law School

Jason is a self-starting, go-getting lawyer who takes a pragmatic approach to helping his clients. He co-founded Fortify Law because he was not satisfied with the traditional approach to providing legal services. He firmly believes that legal costs should be predictable, transparent and value-driven. Jason’s entrepreneurial mindset enables him to better understand his clients’ needs. His first taste of entrepreneurship came from an early age when he helped manage his family’s small free range cattle farm. Every morning, before school, he would deliver hay to a herd of 50 hungry cows. In addition, he was responsible for sweeping "the shop" at his parent's 40-employee HVAC business. Before becoming a lawyer, he clerked at the Lewis & Clark Small Business Legal Clinic where he handled a diverse range of legal issues including establishing new businesses, registering trademarks, and drafting contracts. He also spent time working with the in-house team at adidas® where, among other things, he reviewed and negotiated complex agreements and created training materials for employees. He also previously worked with Meriwether Group, a Portland-based business consulting firm focused on accelerating the growth of disruptive consumer brands and facilitating founder exits. These experiences have enabled Jason to not only understand the unique legal hurdles that can threaten a business, but also help position them for growth. Jason's practice focuses on Business and Intellectual Property Law, including: ​ -Reviewing and negotiating contracts -Resolving internal corporate disputes -Creating employment and HR policies -Registering and protecting intellectual property -Forming new businesses and subsidiaries -Facilitating Business mergers, acquisitions, and exit strategies -Conducting international business transactions ​​ In his free time, Jason is an adventure junkie and gear-head. He especially enjoys backpacking, kayaking, and snowboarding. He is also a technology enthusiast, craft beer connoisseur, and avid soccer player.

Lauren W. on ContractsCounsel
View Lauren
5.0 (1)
Member Since:
December 15, 2022

Lauren W.

Attorney
Free Consultation
Get Free Proposal
New Port Richey, Florida
2 Yrs Experience
Licensed in FL
Western Michigan University Cooley Law School,

Accident and injury attorney. Prior to going to law school I was a paralegal for 12+ years primarily in personal injury. I also worked for a local school district as the Risk Manager and a Buyer in Procurement where I facilitated solicitations and managed all the contracts for the district.

Maigan W. on ContractsCounsel
View Maigan
Member Since:
November 2, 2022

Maigan W.

Principal Attorney
Free Consultation
Get Free Proposal
San Diego, California
2 Yrs Experience
Licensed in CA
California Western School of LaW

Maigan is a registered nurse and attorney with tech law experience, specifically in Web3, including NFTs. Maigan acted as general counsel for a NFT platform for two years and speaks and understands smart contracts. As a registered nurse, Maigan is in a unique position to understand health law issues and graduated with a concentration in health law distinction. Maigan is happy to help you create a business entity, draft and negotiate contracts and agreements, apply for trademarks, draft terms of service and privacy notices, draft terms of sale for NFT drops, draft web3 licenses, and act as a consultant for other attorneys looking for someone who understands web3 and NFTs. Maigan speaks conversational Spanish.

David W. on ContractsCounsel
View David
Member Since:
November 2, 2022

David W.

Attorney
Free Consultation
Get Free Proposal
Texas
7 Yrs Experience
Licensed in TX
South Texas College of Law

Founder David W. Weygandt, the Singing Lawyer, is passionate about helping families and businesses stay in tune with what they care about and avoid conflict. When injustice has been done, David is proud to stand up to the modern Goliath and vindicate your rights on your behalf. David lives and practices law in The Woodlands, Texas, and assists clients all across Texas.

Ben P. on ContractsCounsel
View Ben
Member Since:
November 28, 2022

Ben P.

Partner
Free Consultation
Get Free Proposal
Overland Park, KS
21 Yrs Experience
Licensed in KS, MO, VA
American University, Washington College of Law

Ben Prell is a “business concern” lawyer. Whether a legal issue or concern could develop into a dispute, or already has, he stands ready to advise, assist, and advocate for his clients. Over more than 20 years of practice, Ben has represented clients in all manner of business disputes. He has handled matters that include business ownership and control disputes, non-competition agreements, contract breaches, employment disputes, securities fraud, misappropriation of trade secrets, and intellectual property infringement. Ben provides advice and counsel to businesses regarding litigation and regulatory risk management, compliance with federal regulations, and contract negotiation, revisions and updates. Ben’s recent work includes the successful resolution of cases involving the defense of C-Level executives who became embroiled in larger disputes with their company’s buyers or creditors and the disputed ownership and control of multiple businesses. He has also served as counsel for court-appointed receivers, brought wrongful termination and compensation claims by executives and minority shareholders and addressed securities fraud claims, a partnership claim related to the development of a cellulosic ethanol plant, and a contract dispute involving information technology services. His efforts on behalf of his clients led to his recognition as one of Kansas and Missouri’s Rising Stars by Super Lawyers®.

Ari G. on ContractsCounsel
View Ari
Member Since:
November 28, 2022

Ari G.

Of Counsel
Free Consultation
Get Free Proposal
Ann Arbor, MI
2 Yrs Experience
Licensed in MI
University of Michigan

Ari is a transactional attorney with substantial experience serving clients in regulated industries. He has worked extensively with companies in regulated state cannabis markets on developing governance documents (LLC operating agreements, corporate bylaws, etc...), as well as drafting and negotiating all manner of business and real estate contracts.

Evan F. on ContractsCounsel
View Evan
Member Since:
December 3, 2022

Evan F.

Attorney & Founding Member
Free Consultation
Get Free Proposal
Livonia, MI
3 Yrs Experience
Licensed in MI
Wayne State University Law School

I am the Founding Member of Evan Ficaj Law Firm PLLC, and I am passionate about helping businesses launch, grow, and succeed. My law firm assists clients with business, contract, entertainment, IP, and estate planning matters.

Michael C. on ContractsCounsel
View Michael
Member Since:
December 5, 2022

Michael C.

Owner / Managing Attorney
Free Consultation
Get Free Proposal
Staten Island, New York
11 Yrs Experience
Licensed in NJ, NY
Widener University Commonwealth Law School

We are business and immigration attorneys, committed to delivering compassion-driven and innovative legal solutions that better our clients' lives. Founded in 2019, Carbone Law provides legal services tailored to the unique needs of our clients. We pride ourselves in building a personable attorney-client relationship and are dedicated to establishing a complete understanding of our client’s legal issues, so that we can develop an effective plan for achieving their desired results. Michael T. Carbone, Esq. started Carbone Law with the goal of delivering exceptional legal services to his community. At Carbone Law, Michael counsels individuals and small businesses on a variety of legal issues. Whether aiding families in building successful applications for immigration benefits or advising freelancers and business owners on contract, governance and related issues and the complexities of complying with federal, state and local laws, Michael is committed to building a lasting relationship with his clients.

David C. on ContractsCounsel
View David
Member Since:
December 6, 2022

Find the best lawyer for your project

Browse Lawyers Now

Want to speak to someone?

Get in touch below and we will schedule a time to connect!

Request a call