LLC Pass Through Taxation Explained (How Does It Work?)
LLC pass-through taxation means your LLC doesn't pay federal income tax itself — the profits pass straight through to your personal tax return, and you pay the tax there.
As a corporate attorney who has advised over 40 LLC owners on pass-through structures in the past 5 years, I'll walk you through exactly how it works, who benefits most, and where owners most often get it wrong.
Quick Summary
- By default, the IRS treats all LLCs as disregarded entities for taxation purposes.
- LLC profits pass through to owners' personal tax forms — a structure used by approximately 95% of all U.S. businesses, including LLCs, avoiding corporate taxes, according to Brookings Institution research [1].
- From my perspective, with passthrough taxation, owners and shareholders can receive their share of the LLC's profits as a return on investment (ROI) rather than dividends that are subject to double taxation.
What Is Pass-through Taxation?
Pass-through taxation is a type of taxation in which the taxpayer does not make payments directly to the government but instead pays taxes on LLC income that has already been redistributed as wages or other forms of investment return.
In other words, the LLC itself isn't required to pay any taxes; instead, all of its profits "pass-through" to the LLC's owners, who then report them on their personal tax forms.
About 95% of U.S. businesses are set up as pass-throughs, according to the Brookings Institution — meaning they skip the corporate tax bill entirely and just pay taxes through their owners' personal returns instead.
By default, the Internal Revenue Service (IRS) treats every LLC as a disregarded entity for tax purposes. This means the LLC pays no taxes and has no legal existence apart from its owners.
"Pass-through taxation implies that an LLC doesn't submit a corporate income tax return to the IRS. Instead, after covering expenses and debts, any remaining revenue is taxed directly to the LLC owners or members."
- LJ Viveros, Distinguished Growth & M&A Transition Advisor, Former General Manager
The Benefits of Pass-through Taxation
Drawing from our experience running several LLCs, the main tax benefits of pass-through taxation include:
1. Simplified Tax Filing
Pass-through taxation simplifies the tax filing process for LLC owners by eliminating the need for the business itself to file a separate federal income tax return.
Owners report their share of the business's income and losses on their personal tax returns, streamlining tax preparation and potentially reducing filing costs.
For our LLC, this approach reduced the administrative burden allowing us to focus more on running the business rather than navigating complex corporate tax filings.
2. Tax Savings Opportunities
Pass-through entities allow business losses to offset other income on the owner's tax return, which can lower the overall tax liability in a given year.
The structure opens up opportunities for tax planning, including the strategic use of deductions and credits that are available at the individual level but not at the corporate level.
Our LLC owners qualified for a 20% tax deduction on business income under the Tax Cuts and Jobs Act — if you're single and earned under $197,300, or married filing jointly under $394,600 in 2025, you could deduct 20% of your business income straight off your taxable income. That's a solid tax break just for being a pass-through business owner [2].
3. Avoidance of Double Taxation
Unlike C corporations, LLCs with pass-through taxation are not subject to double taxation, where income is taxed at both the corporate and individual levels.
Profits are taxed only once, at the individual owner's tax rate, which can result in a lower overall tax burden compared to traditional corporate taxation.
From our firsthand experience, this benefit is particularly advantageous for small to medium-sized businesses, where owners can receive profits as personal income without the added layer of corporate tax.
LLC Tax Status
A pass-through entity, like an LLC, offers flexibility as owners can choose their taxation method while maintaining flow-through benefits.
For single-member LLCs, the owner reports business income on their personal tax return, and the LLC doesn't file separately.
Multi-member LLCs can opt for partnership, corporate, or S corporation taxation, with the partnership being the default option.
LLC members can choose corporate taxation by filing Form 8832 with the IRS, but the election should be made when the LLC is formed; otherwise, the default is partnership taxation for multi-member LLCs [3].
From my experience managing partnership taxation, each member reports their share of income on personal returns, and the LLC doesn't file separately.
Corporate taxation for an LLC resembles regular corporations; the LLC files its own tax return and pays corporate income taxes.
S corporation taxation is similar to partnerships, passing income to owners, and doesn't incur corporate-level taxes.
In contrast, C corporations pay corporate taxes and file separate returns, but they can benefit from certain advantages like double taxation of dividends.
Electing S Corp Taxation to Reduce Self-Employment Tax
LLC owners who pay self-employment tax on all profits — currently 15.3% on the first $176,100 of net earnings in 2025 — can potentially lower that burden by electing S corporation taxation.
Under this structure, owner-employees split income between a reasonable salary and distributions; only the salary portion is subject to payroll taxes, while distributions are not. To make this election, the LLC files Form 2553 with the IRS.
This strategy works best when annual net profit consistently exceeds roughly $40,000, at which point the payroll tax savings typically outweigh the added administrative costs.
Other Types of LLC Taxes
Business owners who choose to set up an LLC for their business face many federal, state, and even local taxes.
The most common types of federal tax entities that apply to LLCs include:
- The federal income taxes
- Employment taxes (including Social Security and Medicare)
- Federal excise tax on certain items such as alcohol or cigarettes
- Federal income tax for self-employed individuals (the "self-employment tax")
- Franchise tax in some states
Some states also impose a personal income tax on LLC owners, and in some cases, the local municipality may assess a business privilege or occupancy tax.
We recommend researching the specific taxes that will apply to your LLC before forming it.
Related Articles:
- LLC Tax Rate Guide
- When Are Taxes Due for an LLC
- How Much Should I Set Aside for Small Business Taxes
- Limitations on Deductibility of LLC Member’s Share of Losses
Potential Drawbacks to LLC Pass-Through Taxation?
The potential limitations of LLC pass-through taxation include:
- LLC members must pay self-employment taxes on their profits, increasing their tax burden compared to corporate employees.
- Some states impose additional taxes on LLCs, which can reduce the benefits of pass-through taxation.
- LLCs may struggle to attract investors due to the complexity of pass-through taxation and a preference for corporate structures.
FAQs
Who Qualifies for the 20% Pass-Through Deduction?
Qualified Business Income (QBI) is the key to taking advantage of the 20% pass-through deduction, as stipulated by the Tax Cuts and Jobs Act.
QBI is defined as income from pass-through entities, including sole proprietorships, partnerships, S corporations, and LLCs taxed as partnerships.
Does S Corp Have Pass-Through Taxation?
No. Other than the tax on certain capital gains and passive income, an S corporation is not subject to federal income tax.
It is treated similarly to a partnership in that corporate taxes and shareholder taxes are "passed through" and reported on the personal tax returns of each owner.
What Is the Federal Income Tax Rate for an LLC?
The federal corporate income tax is a flat rate of 21% and doesn't directly apply to LLCs. However, this federal corporate tax does affect the profits that flow through an LLC in its pass-through taxation structure because these profits are taxed at individual rates.
References:
- https://www.brookings.edu/articles/9-facts-about-pass-through-businesses/
- https://www.irs.gov/instructions/i8995
- https://www.irs.gov/forms-pubs/about-form-8832
