Pass-Through Taxation
Definition
Pass-through taxation is a tax system where the business entity itself does not pay federal income tax. Instead, the profits and losses "pass through" the business directly to the personal tax returns of the owners, who then pay the tax at their individual income tax rates.
Why it matters
Pass-through taxation is the primary tax benefit of forming an LLC. It allows business owners to avoid the "double taxation" that traditional C-Corporations face. In a C-Corp, the company pays a 21% tax on its profits, and then the owners pay a second tax (dividend tax) when they withdraw those profits. With pass-through taxation (the default for LLCs), the profits are only taxed once—at the owner's personal level.
Example
A single-member LLC earns $50,000 in net profit. Because the LLC is a pass-through entity (specifically a disregarded entity), the LLC itself writes a check to the IRS for exactly $0 in income tax. The owner simply reports that $50,000 on their personal Form 1040 (Schedule C) and pays tax on it alongside their normal personal income.