Tax-pass-through

A tax-pass-through entity is a business structure where the profits and losses are 'passed through' directly to the owners (e.g., shareholders, partners, or members) and are reported on their individual income tax returns, rather than being taxed at the corporate level. This avoids the 'double taxation' that can occur with C corporations, where profits are taxed at the corporate level and again when distributed to shareholders as dividends. Key examples include sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations. The operational flexibility, and potential tax benefits, of a tax-pass-through entity make it a common choice for small and medium-sized businesses.

Tax-pass-through meaning with examples

• Sarah started a consulting business structured as an LLC, a tax-pass-through entity. All of her profits and any business expenses are reported directly on her personal income tax return. This structure allows her to take advantage of business deductions and avoid corporate income tax, streamlining her financial reporting process. This arrangement is a key factor in her business's financial flexibility.
• A group of doctors formed a medical practice operating as an S corporation, which functions as a tax-pass-through. Each doctor's share of the practice's profits and losses is distributed to them based on their ownership stake. This eliminates the corporate tax burden, simplifying the tax calculation, and enabling the doctors to manage their individual tax liabilities more effectively while promoting financial efficiency.
• The investment fund established a tax-pass-through partnership structure, where the fund's profits from trading are passed directly to the investors. This structure simplifies the tax process for the fund's investors, and enables them to include those profits into their tax returns for full transparency. This design has played a key role in encouraging investors to be involved in the fund.
• A small family farm is organized as a sole proprietorship, which also works as a tax-pass-through. All of the farm's income and deductions are combined with the owner's personal income. They benefit from this streamlined reporting process. The avoidance of corporate tax encourages financial management and helps keep the farm profitable despite varying market conditions.