How Is Pass-Through Income Taxed?

Pass-through taxation applies to entities like sole proprietorships, partnerships, S corporations, and some LLCs, where business income is not taxed at the corporate level. Instead, profits and losses flow through to the owners, who report the income on their personal tax returns and pay tax at their individual rates. Depending on the business type, owners may also owe self-employment tax or qualify for the 20% qualified business income deduction under Section 199A.

A financial advisor may be able to help you evaluate tax strategies that reduce your liability.

What Is Pass-Through Income?

Pass-through income comprises the profits earned by a business that are distributed to owners and shareholders without the entity paying taxes. Taxes on profits are a normal part of business, but certain types of entities “pass through” their income and are not subject to entity-level taxation. Recipients are responsible for paying tax on the income they receive, and losses may also pass through to offset other taxable income.

Which Business Entities Have Pass-Through Income?

Not all businesses qualify for pass-through income. The most common types of businesses that have pass-through income include:

In many cases, these business entities are closely aligned with a single business owner or a small group of investors. These entities pass along both the profits and the losses that a business may incur each tax year. LLCs, in particular, can elect how they are taxed and may qualify for pass-through treatment if they choose to be taxed as a sole proprietorship or partnership. LLCs with multiple members are typically taxed as partnerships by default unless an election is made to be taxed as a corporation.

Who Pays Taxes on Pass-Through Income?

When a pass-through entity makes distributions to shareholders or partners, the recipients are the ones who pay taxes on those profits. In most scenarios, these distributions are labeled ordinary income for tax purposes.

For example, imagine two siblings are equal partners in a business. While the partnership must file a tax return, it is not required to pay taxes. Instead, each sibling is responsible for paying taxes on their share of the income. Even if profits aren’t distributed in cash, each partner may still owe tax on their share of the income.

How Pass-Through Taxation Works

SmartAsset: How Is Pass-Through Income Taxed?

Pass-through income is taxed as ordinary income, which is generally the highest tax brackets that taxpayers pay. In 2025, ordinary income tax rates range from 10% to 37%. The tax rate that applies to your income depends on your filing status and how much you make.

High-income taxpayers may also owe a net investment income tax (NIIT) of 3.8% on unearned income. Depending on how you earned the pass-through income, it could be subject to this additional tax burden. Additionally, it could push your adjusted gross income high enough that other sources of income must also pay these extra taxes.

Self-employment tax may also apply to some pass-through income, particularly for sole proprietors and general partners.

How Can Pass-Through Income Reduce Taxes?

Under the Tax Cuts and Jobs Act of 2017, owners of pass-through businesses became eligible for a deduction of up to 20% on certain types of income. This includes Qualified Business Income (QBI), as well as income from qualified REIT dividends and publicly traded partnerships. The provision, often referred to as the Section 199A deduction, effectively reduces the amount of income subject to tax for those who qualify.

Is the Pass‑Through Tax Deduction Permanent?

The One Big Beautiful Bill Act, which President Trump signed into law on July 4, 2025, makes the QBI deduction permanent. That deduction had been scheduled to expire at the end of the 2025 tax year. It also increases the phase‑out thresholds: single filers may earn up to $75,000 (up from $50,000) and joint filers up to $150,000 (up from $100,000) before limitations kick in.

Can You Reduce Taxes on Pass-Through Income?

Because pass-through income is taxed as ordinary income, investors may benefit from incorporating tax-reduction strategies into their financial plan. If you need to reduce your taxable income, here are some common strategies to consider:

Create or contribute to a company retirement plan. If you have a job that offers a company retirement plan like a 401(k), contribute as much as possible. For investors who own a business, consider creating your own company retirement plan.
Maximize individual retirement accounts (IRAs). Contribute the maximum to a Traditional IRA for you and your spouse. Be aware of income limitations for you or your spouse if either of you has access to a company retirement account at your workplace.
Health savings accounts (HSAs). HSAs require a high-deductible medical insurance policy, so look at your medical needs first. These accounts offer triple tax advantages: a tax deduction now, the money grows tax-deferred and it can be withdrawn tax-free for eligible medical expenses.
Minimize taxable income on investments. Reduce your taxable income by placing income-producing investments into tax-advantaged accounts. For example, REITs and bonds have regular distributions that increase your taxable income. You may consider holding these investments in a retirement account to avoid paying taxes on the income they produce each year.
Realize losses on investments. If you have investments that are worth less than you’ve paid for them, consider selling them to realize the losses to offset your income. You can offset an unlimited amount of capital gains and up to $3,000 of ordinary income each year.

Bottom Line

Pass-through income avoids taxation at the business entity level. Instead, the profits are distributed to business owners, shareholders, and partners as ordinary income. Although taxed at ordinary income rates, pass-through income may be managed with strategic planning. A tax professional or financial advisor can help you explore available deductions and planning opportunities.

Tips for Lowering Your Taxes

A financial advisor can help you optimize your financial plan and potentially lower your tax liability. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
To lower your taxes, it helps to forecast what your tax obligations may be. SmartAsset’s federal income tax calculator estimates how much you owe in taxes based on your income, location, filing status, and deductions.