Tax
Passthrough Entity
A business entity that doesn't pay federal income tax at the entity level; income passes through to the owners on K-1s and is taxed on their personal returns. Covers partnerships, S-corps, and most LLCs — the default tax shape for U.S. small businesses.
Partnerships, S-corps, and most LLCs are passthrough entities. The entity files an informational return (1065 or 1120-S), but the actual tax is owed by the owners on their personal returns.
C-corps are not passthrough: they pay tax at the entity level, and shareholders pay again on dividends (the 'double taxation' issue).
The four passthrough shapes in common use: single-member LLC (disregarded — reported directly on Schedule C or E of the owner's 1040, no separate return); multi-member LLC or partnership (files 1065, issues K-1s); S-corp (files 1120-S, K-1s, owner-employees run payroll); and grantor trust (income passes to the grantor's 1040 without a separate trust return). Which shape you're in changes the tax paperwork, the owner-comp rules, and the state-tax overlay.
The PTET workaround has changed passthrough tax planning materially since 2018. Most states with income tax now let a passthrough elect to pay state tax at the entity level and get a federal deduction, which the owner then credits on their personal state return. For high-income owners in high-tax states this recovers most of the SALT-cap loss. The elections have real deadlines (March 15 in NY, June 15 in CA prepayment) and must be re-elected annually in some states.
For M&A and buyer diligence, passthrough shape matters. A buyer of an S-corp gets a §338(h)(10) election opportunity that turns the stock sale into an asset sale for tax purposes — meaningful basis step-up for the buyer, capital-gain treatment for the seller. A partnership sale can use §754 election to step up basis of assets to the buying partner. LLCs and C-corps have different sale mechanics. Structuring the sale correctly is often 5-10% of the deal value.
Common pitfalls
- Forgetting to make state-level entity tax elections (PTET) that work around the SALT cap
- Confusing legal form (LLC) with tax form (passthrough or C-corp election)
- Missing single-member-LLC state filing requirements — some states (CA, TN, TX) require the disregarded LLC to file at the entity level even when the IRS ignores it
- Treating passthrough income as tax-free to the owner because the entity paid no tax; it's fully taxable on the personal return
- Not modeling the §338(h)(10) or §754 election opportunity BEFORE the sale — post-signing structural fixes are usually impossible
Related service
See tax and CPA servicesHave a Passthrough Entity situation in your business?
Federal, state, and local returns prepared and reviewed by a licensed CPA, with the planning done before year-end rather than after it.