{"id":2136,"date":"2025-10-25T08:21:48","date_gmt":"2025-10-25T08:21:48","guid":{"rendered":"https:\/\/www.cpapilot.com\/blog\/?p=2136"},"modified":"2025-11-11T11:34:32","modified_gmt":"2025-11-11T11:34:32","slug":"pass-through-entity","status":"publish","type":"post","link":"https:\/\/www.cpapilot.com\/blog\/pass-through-entity\/","title":{"rendered":"Pass-Through Entity &#8211; Types, Tax Rules &amp; Section 199A Explained"},"content":{"rendered":"\n<p>Pass-through entities offer one of the most tax-efficient ways to structure a business in the U.S., particularly for small to mid-sized business owners, professional service firms, and partnerships.&nbsp;<\/p>\n\n\n\n<div class=\"wp-block-group has-pale-cyan-blue-background-color has-background\"><div class=\"wp-block-group__inner-container is-layout-constrained wp-block-group-is-layout-constrained\">\n<h3 class=\"wp-block-heading\"><strong>\u2705 TL;DR: Key Takeaways on Pass-Through Entities<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>What is it?<\/strong> A pass-through entity lets business income flow directly to owners\u2019 tax returns\u2014avoiding double taxation.<\/li>\n\n\n\n<li><strong>Entity Types:<\/strong> Includes sole proprietorships, partnerships, LLCs, and S-corporations.<\/li>\n\n\n\n<li><strong>IRS Forms:<\/strong> Owners report income via Schedule C or E; entities file Form 1065 or 1120S with K-1s.<\/li>\n\n\n\n<li><strong>Section 199A:<\/strong> Eligible owners may deduct up to 20% of Qualified Business Income (QBI).<\/li>\n\n\n\n<li><strong>PTET Workaround:<\/strong> Over 30 states allow pass-through entities to pay state taxes directly to preserve federal deductions.<\/li>\n\n\n\n<li><strong>State Conformity:<\/strong> States like Colorado and Utah conform to Section 199A; California and NJ do not.<\/li>\n\n\n\n<li><strong>Best For:<\/strong> Small businesses, professionals, and firms not seeking venture capital or public stock offerings.<\/li>\n<\/ul>\n<\/div><\/div>\n\n\n\n<p>In this guide, we explain what pass-through entities are, the various types available, how pass-through taxation works, and how the&nbsp;<a href=\"https:\/\/www.irs.gov\/newsroom\/qualified-business-income-deduction\" target=\"_blank\" rel=\"noopener\">Section 199A deduction<\/a>&nbsp;applies\u2014plus a breakdown of which states conform to this provision.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>What is a Pass-Through Entity?<\/strong><\/h2>\n\n\n\n<p>A&nbsp;<strong>pass-through entity<\/strong>&nbsp;is a business structure where income, deductions, and credits \u201cpass through\u201d the business and are reported directly on the individual tax returns of the owners. These entities do&nbsp;<strong>not pay federal income tax at the entity level<\/strong>.<\/p>\n\n\n\n<p>Instead, each owner pays tax on their share of the income at their&nbsp;<strong>individual tax rate<\/strong>.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Why Is It Called \u201cPass-Through\u201d?<\/strong><\/h3>\n\n\n\n<p>The term refers to how the&nbsp;<strong>tax liability passes through the business<\/strong>&nbsp;and is absorbed by its owners. This avoids the&nbsp;<strong>double taxation<\/strong>&nbsp;faced by&nbsp;<a href=\"https:\/\/en.wikipedia.org\/wiki\/C_corporation\" target=\"_blank\" rel=\"noopener\">C-corporations<\/a>, where income is taxed at both the corporate and shareholder levels.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>What Taxes Do Owners Pay?<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Federal income tax<\/strong>&nbsp;on their share of profits<\/li>\n\n\n\n<li><strong>Self-employment tax<\/strong>, depending on the entity type<\/li>\n\n\n\n<li><strong>State-level taxes<\/strong>, where applicable<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>What Are the Different Types of Pass-Through Entities?<\/strong><\/h2>\n\n\n\n<p>There are four main types of pass-through entities, each with different legal requirements, tax treatment, and setup procedures:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>1. Sole Proprietorship<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Default structure for solo business owners<\/li>\n\n\n\n<li>Reported on&nbsp;<a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-schedule-c-form-1040\" target=\"_blank\" rel=\"noopener\"><strong>Schedule C<\/strong>&nbsp;of Form 1040<\/a><\/li>\n\n\n\n<li>Unlimited personal liability<\/li>\n\n\n\n<li>No need for a separate business tax return<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>2. Partnership<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li>For two or more co-owners<\/li>\n\n\n\n<li>Files&nbsp;<a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-form-1065\" target=\"_blank\" rel=\"noopener\"><strong>Form 1065<\/strong>&nbsp;with the IRS<\/a><\/li>\n\n\n\n<li>Income split between partners via&nbsp;<a href=\"https:\/\/www.irs.gov\/pub\/irs-pdf\/f1065sk1.pdf\" target=\"_blank\" rel=\"noopener\">Schedule K-1<\/a><\/li>\n\n\n\n<li>Partners report their share of income on&nbsp;<a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-form-1040\" target=\"_blank\" rel=\"noopener\">Form 1040<\/a><\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>3. Limited Liability Company (LLC)<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Can be single-member or multi-member<\/li>\n\n\n\n<li>Default taxation is pass-through<\/li>\n\n\n\n<li>Can elect to be taxed as an S-corp or C-corp<\/li>\n\n\n\n<li>Offers&nbsp;<strong>limited liability protection<\/strong>&nbsp;and tax flexibility<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>4. S-Corporation<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Requires&nbsp;<a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-form-2553\" target=\"_blank\" rel=\"noopener\"><strong>Form 2553<\/strong>&nbsp;election with IRS<\/a><\/li>\n\n\n\n<li>Files&nbsp;<a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-form-1120-s\" target=\"_blank\" rel=\"noopener\">Form 1120S<\/a>&nbsp;and distributes&nbsp;<strong>Schedule K-1s<\/strong><\/li>\n\n\n\n<li>Avoids double taxation<\/li>\n\n\n\n<li>Profits (after salary) may not be subject to self-employment tax<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>What is a Pass-Through Entity Tax (PTET)?<\/strong><\/h2>\n\n\n\n<p>While pass-through entities avoid federal corporate income tax, some states have created a&nbsp;<strong>Pass-Through Entity Tax (PTET)<\/strong>&nbsp;to address the federal&nbsp;<a href=\"https:\/\/www.cpapilot.com\/blog\/salt-deduction-explained\/\">SALT deduction cap<\/a>.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Why Does PTET Exist?<\/strong><\/h3>\n\n\n\n<p>The&nbsp;<a href=\"https:\/\/www.irs.gov\/newsroom\/tax-cuts-and-jobs-act-a-comparison-for-businesses\" target=\"_blank\" rel=\"noopener\">Tax Cuts and Jobs Act (TCJA)<\/a>&nbsp;capped the deduction for state and local taxes (SALT) at $10,000. To help business owners preserve deductibility, many states enacted&nbsp;<strong>PTET laws<\/strong>&nbsp;allowing the entity to pay state taxes directly\u2014making them&nbsp;<strong>fully deductible at the federal level<\/strong>.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Which States Have PTET?<\/strong><\/h3>\n\n\n\n<p>Over&nbsp;<strong>30 states<\/strong>&nbsp;now offer a PTET workaround. Examples include:\\n<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><a href=\"https:\/\/www.ftb.ca.gov\/forms\/2024\/2024-3804.pdf\" target=\"_blank\" rel=\"noopener\"><strong>California<\/strong>&nbsp;(Form 3804)<\/a><\/li>\n\n\n\n<li><a href=\"https:\/\/www.tax.ny.gov\/bus\/ptet\/\" target=\"_blank\" rel=\"noopener\"><strong>New York<\/strong>&nbsp;(PTET Election via NYS)<\/a><\/li>\n\n\n\n<li><a href=\"https:\/\/www.nj.gov\/njbonds\/treasury\/taxation\/baitpte\/index.shtml\" target=\"_blank\" rel=\"noopener\"><strong>New Jersey<\/strong>&nbsp;(BAIT Program)<\/a><\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>What is the Section 199A Pass-Through Deduction?<\/strong><\/h2>\n\n\n\n<p>Section 199A, also called the\u00a0<a href=\"https:\/\/www.cpapilot.com\/blog\/qualified-business-income-qbi-deduction\/\"><strong>Qualified Business Income (QBI) deduction<\/strong>,<\/a> allows eligible owners of pass-through entities to deduct a portion of their business income from taxable income.<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>For tax year 2025:<\/strong>&nbsp;Owners can deduct&nbsp;<strong>up to 20%<\/strong>&nbsp;of qualified business income.<\/li>\n\n\n\n<li><strong>For tax years after 2025:<\/strong>\u00a0The deduction is expected to increase to\u00a0<strong>23%<\/strong>\u00a0and be made permanent under the\u00a0OBBB (\u201cBig Beautiful Tax Bill\u201d), per proposed and likely-enacted changes.<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Who Can Claim the 199A or QBI Deduction?<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Sole proprietors<\/li>\n\n\n\n<li>S-corp shareholders<\/li>\n\n\n\n<li>Partners in partnerships<\/li>\n\n\n\n<li>LLC members (if the LLC is taxed as a pass-through)<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Are There Limitations?<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Income thresholds:<\/strong>&nbsp;For 2025, above ~$182,000 (single) or ~$364,000 (married), the deduction begins to phase out. New legislation will adjust these amounts upwards for 2026 and beyond.<\/li>\n\n\n\n<li><strong>Business type:<\/strong>&nbsp;Certain Specified Service Trades or Businesses (SSTBs)\u2014such as law, accounting, and consulting\u2014may face additional restrictions.<\/li>\n\n\n\n<li><strong>W-2 wage tests:<\/strong>&nbsp;For high-income taxpayers, eligibility may depend on the amount of W-2 wages paid and\/or the value of business property.<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">Example&nbsp;<\/h3>\n\n\n\n<p>A qualified business earning $200,000 may deduct up to $40,000 (20% of $200,000) from taxable income for 2025. For 2026 and later, the deduction would be $46,000 (23% of $200,000) under the expected new law.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>Which States Conform to IRC Section 199A?<\/strong><\/h2>\n\n\n\n<p><strong>State conformity<\/strong>&nbsp;refers to whether a state has adopted the federal tax law provisions of Section 199A into its own income tax code.<\/p>\n\n\n\n<figure class=\"wp-block-table\"><table class=\"has-fixed-layout\"><tbody><tr><td><strong>Conformity Status<\/strong><\/td><td><strong>States<\/strong><\/td><\/tr><tr><td><strong>\u2705 States That Conform (Fully or Partially)<\/strong><\/td><td><strong>Colorado, Utah, Idaho, North Carolina, Alabama<\/strong><\/td><\/tr><tr><td><strong>\ud83d\udeab States That Do Not Conform<\/strong><\/td><td><strong>California, Massachusetts, New Jersey, Minnesota, Wisconsin<\/strong><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<p>\ud83d\udccc Note: Conformity may change annually. Always check your state\u2019s Department of Revenue or CPA guidance for the most up-to-date alignment with IRC 199A.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>IRS Reporting Requirements for Pass-Through Entities<\/strong><\/h2>\n\n\n\n<p>Even though pass-through entities don\u2019t pay federal income tax directly, they must still file returns and distribute income info to owners:<\/p>\n\n\n\n<figure class=\"wp-block-table\"><table class=\"has-fixed-layout\"><tbody><tr><td><strong>Entity Type<\/strong><\/td><td><strong>IRS Filing Form<\/strong><\/td><td><strong>Owner Reporting Method<\/strong><\/td><\/tr><tr><td><strong>Sole Proprietor<\/strong><\/td><td><a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-schedule-c-form-1040\" target=\"_blank\" rel=\"noopener\">Schedule C (Form 1040)<\/a><\/td><td>Included directly in the owner\u2019s Form 1040 return<\/td><\/tr><tr><td><strong>Partnership<\/strong><\/td><td><a href=\"https:\/\/www.irs.gov\/pub\/irs-pdf\/f1065sk1.pdf\" target=\"_blank\" rel=\"noopener\">Form 1065 + Schedule K-1<\/a><\/td><td>Reported on&nbsp;<a href=\"https:\/\/www.irs.gov\/forms-pubs\/about-schedule-e-form-1040\" target=\"_blank\" rel=\"noopener\">Schedule E (Form 1040)<\/a><\/td><\/tr><tr><td><strong>S-Corporation<\/strong><\/td><td><a href=\"https:\/\/www.irs.gov\/pub\/irs-pdf\/f1120ssk.pdf\" target=\"_blank\" rel=\"noopener\">Form 1120S + Schedule K-1<\/a><\/td><td>Reported on Schedule E (Form 1040)<\/td><\/tr><tr><td><strong>LLC (Default)<\/strong><\/td><td>Same as above (based on election)<\/td><td>Based on tax election \u2014 can be treated as a sole proprietorship, partnership, or corporation<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>Final Thoughts<\/strong><\/h2>\n\n\n\n<p>Pass-through entities offer strategic tax savings and structural simplicity for many U.S. businesses. However, compliance requirements, QBI deduction eligibility, and&nbsp;<strong>state-level tax conformity<\/strong>&nbsp;can significantly impact outcomes. CPAs and business owners should review entity structure annually, especially in light of evolving tax law.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>Pass-Through Entities FAQs<\/strong><\/h2>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>What is the main benefit of a pass-through entity?<\/strong><\/h4>\n\n\n\n<p>It avoids&nbsp;<strong>double taxation<\/strong>&nbsp;by allowing income to be taxed only at the&nbsp;<strong>individual owner level<\/strong>.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Are pass-through entities taxed at the federal level?<\/strong><\/h4>\n\n\n\n<p>No. They are&nbsp;<strong>informational filers<\/strong>. Owners report and pay tax on their allocated share of income.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Can an LLC be taxed as a pass-through entity?<\/strong><\/h4>\n\n\n\n<p>Yes. By default, it is. But it can also elect to be taxed as a C-corp or S-corp.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Is the QBI deduction available to all owners?<\/strong><\/h4>\n\n\n\n<p>Not always. It depends on income, business type, and whether wage limitations apply.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Do all states allow the 199A deduction?<\/strong><\/h4>\n\n\n\n<p>No.&nbsp;<strong>State conformity varies.<\/strong>&nbsp;States like California and New Jersey do&nbsp;<strong>not allow<\/strong>&nbsp;the 199A deduction.<\/p>\n\n\n\n<div class=\"wp-block-group has-luminous-vivid-amber-background-color has-background\"><div class=\"wp-block-group__inner-container is-layout-constrained wp-block-group-is-layout-constrained\">\n<p><strong>Want AI to Handle Tax Research + Compliance?&nbsp;Let CPA Pilot\u2019s tax engine do the heavy lifting.&nbsp;<\/strong>Automate your 1040 research, pass-through compliance, and planning.&nbsp;<\/p>\n\n\n\n<p>\ud83d\udc49&nbsp;<a href=\"https:\/\/www.cpapilot.com\/\">Explore CPA Pilot\u2019s Features<\/a><\/p>\n<\/div><\/div>\n\n\n\n<p><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Pass-through entities offer one of the most tax-efficient ways to structure a business in the U.S., particularly for small to mid-sized business owners, professional service firms, and partnerships.&nbsp; \u2705 TL;DR: Key Takeaways on Pass-Through Entities In this guide, we explain what pass-through entities are, the various types available, how pass-through taxation works, and how the&nbsp;Section [&hellip;]<\/p>\n","protected":false},"author":2,"featured_media":2137,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_lmt_disableupdate":"","_lmt_disable":"","footnotes":""},"categories":[68],"tags":[64,66,67,65],"class_list":["post-2136","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-tax-glossary","tag-pass-through-entities","tag-qbi-deduction","tag-qualified-business-income","tag-section-199a"],"modified_by":"CPA Pilot","_links":{"self":[{"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/posts\/2136","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/comments?post=2136"}],"version-history":[{"count":3,"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/posts\/2136\/revisions"}],"predecessor-version":[{"id":2192,"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/posts\/2136\/revisions\/2192"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/media\/2137"}],"wp:attachment":[{"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/media?parent=2136"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/categories?post=2136"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.cpapilot.com\/blog\/wp-json\/wp\/v2\/tags?post=2136"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}