What Is a Pass-Through Entity and How C Corporations Differ

Key Takeaways

• A pass-through entity is a business structure where profits and losses pass directly to the owners’ personal tax returns, avoiding corporate income tax.
• C corporations differ because they face double taxation — once on corporate profits and again when shareholders receive dividends.
• Pass-through entities include sole proprietorships, partnerships, S corporations, and LLCs that elect pass-through taxation.
• The Tax Cuts and Jobs Act (TCJA) introduced the Qualified Business Income (QBI) deduction, allowing eligible pass-through owners to deduct up to 20% of qualified income.
• Pass-through structures offer simplicity and flexibility, while C corporations are more suited for larger businesses seeking investment or going public.
• Choosing between a C corporation and a pass-through entity depends on business goals, size, funding needs, and tax strategy.

C Corporations are Taxed as a Pass Through Entity

C corporations are taxed as a pass through entity, meaning that, if any profits of the corporation are distributed to its shareholders in the form of dividends, then those shareholders must pay personal income tax on such dividends. Therefore, while it does ‘pass through’ in a sense, the C corporation is still double taxed – once at the corporate level and then again at the personal level.

When a business incorporates, it can choose to operate as either a C or S corporation. There are many benefits to both, as well as some disadvantages. It is important to ensure that you understand all of your rights and responsibilities in operating each type of business structure before choosing which type of corporation to operate.

Overall, many business structures do actually operate as flow-through entities because the business itself is not required to pay corporate income tax. For example, for sole proprietorships, partnerships, and S corporations, the business profits and losses flow to the owners and shareholders. This means that those individuals will report profits on their own personal tax return, but can only pay on tax that is equivalent to the amount of capital they invested in the business. Furthermore, these companies can potentially deduct business losses, thereby reducing their taxes owed.

Key Tax Benefits of Pass-Through Entities

Pass-through entities are popular among small and mid-sized businesses because of their tax efficiency. Owners can reduce their taxable income through deductions and credits that apply directly to their share of profits. The Tax Cuts and Jobs Act (TCJA) introduced a significant benefit — the Qualified Business Income (QBI) deduction, allowing eligible owners to deduct up to 20% of their qualified business income from pass-through entities.

Other key benefits include:

• Single layer of taxation: Profits are only taxed once at the individual level.
• Business loss deductions: Losses can offset other income, reducing total taxable income.
• Simplified filing: Reporting pass-through income is often easier than corporate tax compliance.
• Tax flexibility for LLCs: LLCs can choose to be taxed as a sole proprietorship, partnership, or S corp.
• Potential savings for certain professions: Professionals such as doctors, consultants, and freelancers often benefit from the QBI deduction if they qualify.

However, eligibility for the QBI deduction depends on several factors, including income thresholds, type of business, and W-2 wage or qualified property limitations.

Understanding What Is a Pass-Through Entity

A pass-through entity is a type of business structure that allows income, losses, deductions, and credits to “pass through” directly to the owners or members, rather than being taxed at the corporate level. This means that the IRS does not impose corporate income tax on the business itself — instead, the owners report the business’s income on their individual tax returns, paying at their personal tax rates.

Common types of pass-through entities include:

• Sole proprietorships – Income is reported on the owner’s personal tax return (Schedule C).
• Partnerships – Profits and losses pass to partners based on their ownership percentage.
• Limited Liability Companies (LLCs) – By default, single-member LLCs are treated as sole proprietorships, and multi-member LLCs as partnerships; they can also elect S corp status for potential tax savings.
• S corporations (S corps) – Avoid corporate income tax, but must meet strict eligibility rules like a 100-shareholder limit and U.S. citizenship/residency requirements.

Because pass-through entities don’t pay income tax at the entity level, owners benefit from avoiding double taxation, unlike C corporations. However, owners are still responsible for self-employment taxes on their share of business income, unless they structure their compensation strategically.

C Corp Advantages

There are still many advantages to operating a C corp, and these include:

• Health insurance and other fringe benefits are not subject to ordinary income tax or employment taxes, which is generally the case with other business structures.

• Income can be split between the owners and the corporation. This is generally done to reduce overall taxes.

• Since the C corporation can issue an unlimited amount of shares, the corporation can increase its profits and funding by simply selling shares of stock.

While there are advantages and disadvantages (double taxation) to operating a C corp, you can also choose to operate as an S corp. Some items of consideration include the fact that C corps are so highly regulated and have a significant amount of government oversight. For this reason, such corporations might require the help of an accountant as well as an attorney to help in the accounting and legal departments.

When you initially incorporate, keep in mind that your corporation automatically defaults to a C corp. If you want to operate as an S corp, you must elect to do so.

If the business is going to earn profits from the very beginning, then operating a C corp would offer greater tax saving opportunities, along with more funding resources for future growth of the business. If, however, your business is expecting to incur a loss in the beginning of its operations, then you might want to elect to operate as an S corp so that the losses pass through to the owners, which they can then deduct against other earned income. Once you see your business turning a profit, you can then convert your corporation back to a C corp.

Comparing C Corporations and Pass-Through Entities

While C corporations provide stronger investor appeal and allow for easier capital accumulation, they face double taxation — once on corporate profits and again when shareholders receive dividends. In contrast, pass-through entities offer a more tax-efficient model for smaller businesses or those not seeking venture capital

Comparison at a glance:

Choosing between these structures depends on your long-term goals. For instance, a business planning to reinvest earnings and attract investors might choose a C corporation, while one seeking to minimize taxes and maintain operational flexibility might prefer a pass-through structure like an LLC or S corp.

Taxation of C Corporations

A corporation is treated as a separate legal entity; therefore, it can purchase property, sue other parties, be named as a defendant in a lawsuit, and even enter into a contract. For that reasons, shareholders benefit from limited liability. The liability is limited because the only amount for which the shareholder can be held liable is the amount of money that he or she invested in the corporation. Their other personal assets cannot be taken, whether it be homes, automobiles, bank accounts, etc.

Keep in mind that there are some exceptions to this rule, particularly regarding potential fraudulent activities. If this is the case, the law would allow what’s called a ‘piercing of the corporate veil’ to hold one or more shareholders liable.

A C corporation has to use the accrual method of accounting if the gross receipts exceed $5 million for the preceding three tax years. If the corporation has not been in business for a period of three or more years, then you must calculate the average for the time in which the business has been operating. If the time period is less than one year, then the income would be annualized.

Pass-Through vs. Double Taxation Explained

The core difference between C corporations and pass-through entities lies in how income is taxed. A C corporation is a separate taxpayer — it must pay taxes on profits at the corporate level, and shareholders pay taxes again when dividends are distributed. This results in the well-known “double taxation” scenario.

By contrast, pass-through entities avoid this duplication. Income “flows through” to the owners’ tax returns and is taxed once. However, this advantage can come with trade-offs:

• Owners of pass-through entities may owe self-employment taxes on profits.
• They might face state-level taxes depending on jurisdiction (some states levy entity-level fees).
• High-income owners could see limitations on the QBI deduction or face phase-out thresholds.

Still, for most small businesses, the reduction in overall tax burden and simplicity of pass-through taxation make it an attractive option.

Frequently Asked Questions

1. What is a pass-through entity in simple terms?
   A pass-through entity is a business where profits and losses are passed directly to the owners’ personal tax returns, avoiding corporate-level income tax.
2. Is a C corporation a pass-through entity?
   No. A C corporation is not a pass-through entity because it pays corporate income tax and shareholders pay again on dividends.
3. What types of businesses qualify as pass-through entities?
   Sole proprietorships, partnerships, LLCs, and S corporations are common pass-through entities.
4. What is the main tax benefit of a pass-through entity?
   The main benefit is single-layer taxation and eligibility for the 20% Qualified Business Income deduction.
5. How do I know if a pass-through entity is right for my business?
   It depends on your business goals, income level, and growth plans. Consulting a tax attorney or accountant can help determine the best structure.

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