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 is business income that is not generally taxed at the entity level. Instead, the income, deductions, credits and other tax items pass through to the business owners, who report their share on their individual tax returns. This structure is common among sole proprietorships, partnerships, S corporations and many limited liability companies.

The amount of pass-through income an owner reports depends on the business structure and the owner’s share of profits and losses. For example, partners in a partnership generally receive a Schedule K-1 showing their portion of the business’s taxable income, while S corporation shareholders receive similar tax reporting based on their ownership interests.

Pass-through income is usually subject to ordinary federal income tax rates rather than corporate income tax rates. Depending on the type of business and the owner’s involvement, some income may also be subject to self-employment taxes or other taxes. Certain owners may also qualify for the qualified business income deduction, which can reduce the amount of eligible business income subject to federal income tax.

One advantage of pass-through taxation is that it generally avoids the double taxation associated with traditional C corporations, where profits may first be taxed at the corporate level and then again when distributed to shareholders as dividends. However, pass-through owners can still owe tax on allocated income even if the business does not distribute that money to them in cash.

Which Business Entities Have Pass-Through Income?

Several common business structures use pass-through taxation, meaning the business generally does not pay federal income tax on its profits at the entity level. Instead, profits and losses are reported by the owners on their personal tax returns, although the exact tax treatment depends on the type of entity.

Sole proprietorships are the simplest example. A sole proprietor generally reports business income and expenses on Schedule C of Form 1040, and net earnings are typically subject to both income tax and self-employment tax.

Partnerships also use pass-through taxation. The partnership files an informational tax return, but each partner generally receives a Schedule K-1 showing their share of income, deductions, credits and other tax items. Partners then report those amounts on their individual returns, even if the business does not distribute all of the income in cash.

S corporations operate similarly in that business income generally passes through to shareholders. Shareholders report their allocated share of profits on their personal returns, while owners who work for the business are typically required to receive reasonable compensation as wages. Those wages are subject to payroll taxes, while qualifying S corporation distributions generally are not subject to self-employment tax.

Limited liability companies can also have pass-through income, but their tax treatment depends on how they are classified for federal tax purposes. A single-member LLC is generally taxed like a sole proprietorship by default, while a multi-member LLC is generally taxed as a partnership. An LLC may also elect to be taxed as an S corporation or C corporation.

Certain trusts and other entities can also pass income through to beneficiaries or owners under different tax rules. Because each structure has its own filing requirements and tax consequences, business owners may want to compare how income taxes, payroll taxes and liability protection differ before choosing an entity type.

Who Pays Taxes on Pass-Through Income

The owners of a pass-through business generally pay the federal income tax on the business’s profits rather than the business itself. Depending on the entity, that may include a sole proprietor, partner, LLC member or S corporation shareholder. Each owner reports their allocated share of taxable income on their individual tax return.

Importantly, owners may owe tax on income allocated to them even if the business does not actually distribute that amount in cash. For example, a partnership could retain some of its profits for operating expenses while still passing taxable income through to its partners. This can create a tax bill without an equivalent cash distribution.

The type of tax an owner pays also depends on the business structure and the nature of the income. Sole proprietors and many general partners may owe both income tax and self-employment tax on business earnings, while S corporation shareholders generally pay payroll taxes on wages they receive from the company but not on qualifying distributions.

Owners may also have to make quarterly estimated tax payments because pass-through income typically does not have taxes automatically withheld. State and local taxes can apply as well, and some jurisdictions impose separate entity-level taxes or fees even on pass-through businesses.

The final amount owed depends on factors such as the owner’s taxable income, filing status, deductions and eligibility for tax breaks such as the qualified business income deduction. Since pass-through taxation can affect both business and personal tax planning, owners may benefit from estimating their liability throughout the year rather than waiting until tax season.

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. Finding a financial advisor doesn’t have to be hard. 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.