Glossary of Terms

Pass-Through Entity 2019-03-09 08:00:00

Pass-Through Entity

A pass-through entity is any business organized as a partnership, limited-liability company, S-corporation or sole-proprietorship that reports any profit on its owners’ tax returns -- "passing it through" to them. Pass through entities avoid taxes at the corporate level, reducing the effects of double taxation. Instead, income is allocated amongst the owners, based on percent ownership, and taxed at the individual owner’s marginal tax rate.

For example, Company A has four owners, which each individual owning an equal 25%. After a successful year, Company A saw a net income of $500,000, with each owner having claim to $125,000 of the profits that will be reported on their respective tax returns. Note that if the owners elected to retain the earnings within the business, not distributing it, the owners would still be liable for the taxes on the income they would’ve received, creating a phantom income situation.