Key Takeaways

  • An LLC pass through means the LLC itself generally does not pay federal income tax; instead, profits and losses are reported on each member’s personal tax return.
  • LLCs can choose different tax classifications, including sole proprietorship, partnership, S corporation, or C corporation, which can change how pass-through taxation applies.
  • Members may need to pay self-employment taxes on LLC income, but electing S corporation status can reduce this burden for some owners.
  • Certain states impose their own LLC taxes or fees, even on pass-through entities.
  • Deductions, credits, and the Qualified Business Income (QBI) deduction can help lower taxable income for pass-through LLC members.

An LLC pass through refers to the pass-through characteristic of this type of business entity when it comes to taxation. The profits and losses of a Limited Liability Company (LLC) pass through the company and on to the members (owners) of the business. 

What Is an LLC?

Along with protection for the assets of owners (members), an LLC business structure also offers the tax structure of a sole proprietorship or partnership.

Any profits or losses for the company pass on to the members, so business income is actually taxed through the personal income tax returns of the members, not the company itself. 

It is a bit harder to form an LLC than it is a sole proprietorship or partnership, but it's much easier than a corporation. LLCs are becoming the most popular business structure in the United States today. 

How Pass-Through Taxation Works for LLCs

Pass-through taxation means that the Internal Revenue Service (IRS) does not treat the LLC as a separate taxpayer for federal income tax purposes (unless it elects corporate taxation). Instead, the business’s profits, losses, deductions, and credits are “passed through” to its owners, who report them on their individual tax returns. This avoids the double taxation that corporations face, where both the company and shareholders are taxed.

By default:

  • A single-member LLC is taxed as a disregarded entity, with income reported on Schedule C (or E/F for certain income types).
  • A multi-member LLC is taxed as a partnership, with the business filing Form 1065 and providing each member a Schedule K-1 to report their share.

Owners pay income tax on the LLC’s net earnings whether or not profits are distributed. Additionally, most LLC members must pay self-employment tax on their share of earnings, which covers Social Security and Medicare contributions.

Main Features of an LLC

The members, also known as the owners, of an LLC are protected from liabilities if the business goes under or has any legal issues, just like the shareholders in a corporation. In the case that an LLC goes into debt with a credit company or supplier, that company cannot go after the personal assets of any of the members. The only thing the members could possibly lose in a problem with the LLC is their capital investment. This is what the "limited liability" refers to in the business structure's name. 

This liability protection is also offered with a corporate business structure, but both corporations and LLCs have exceptions to this rule. LLC members can be subject to personal liability if:

  • The member injures another person.
  • The member guarantees payment on a bank or business loan personally and then the company defaults.
  • The member does not pay tax withholdings from payroll.
  • The member participates in fraud or illegal or dangerous activities that lead to issues for the company or harm another individual.
  • The member fails to keep an appropriate separation between the company and their personal interests or actions. 

An LLC can be dissolved if it is found that it is not being handled as a separate legal entity. In order to avoid having a court decide that the company members have not kept appropriate separation between company affairs and personal affairs, owners must:

  • Conduct all business within legal bounds and fairly to customers.
  • Be honest about company finances and other facts with clients, vendors, and anyone else interacting professionally with the company.
  • Make sure that the company has the necessary funds to properly do business.
  • Keep LLC business and personal business completely separated, especially bank accounts and all finances.
  • Obtain an EIN (Employer Identification Number) for the LLC.
  • Formulate an Operating Agreement.

Also, insurance companies offer liability policies to business owners as an added protection for their personal assets. These are ideal for services that include risks like massage therapy, snowboarding lessons, and others.

If the limited liability status of an LLC is overruled by a court, liability insurance can still provide coverage. 

Protection is only granted in cases of lawsuits and the like, but LLCs can't be protected from paying off business debts. 

LLC Tax Classification Options

While most LLCs keep the default pass-through classification, members can elect a different tax treatment by filing IRS Form 8832 (for C corporation status) or Form 2553 (for S corporation status).

Common classification choices include:

  1. Default sole proprietorship or partnership (pass-through) – Simple reporting, but owners pay self-employment tax on the entire share of profits.
  2. S corporation election – Still a pass-through entity, but allows owners to take a “reasonable salary” subject to payroll taxes, while remaining profits may avoid self-employment tax.
  3. C corporation election – The LLC pays corporate income tax, and any dividends distributed to owners are taxed again on personal returns (double taxation). This structure may make sense if profits are reinvested or to access certain corporate deductions.

Income Taxes for LCC Members

As a pass-through type of business structure, an LLC isn't required to pay federal income tax. Certain states do require LLCs to pay annual state business taxes, however.

In the eyes of the IRS, a multi-member LLC is seen as a partnership unless it has opted for a different taxation status. Owners of the LLC will pay income taxes on the profits they acquire from the company according to their shares with a Schedule E form attached to their personal tax returns. 

The amount allotted for each member of the LLC should be spelled out in the operating agreement. These distributive shares can be according to the principle interest each member took on as the company was formed, or they can reflect the amount of management responsibilities of the members. 

Single-member LLCs are viewed as disregarded entities; therefore, the owner is required to report the profits and losses of the company on their Schedule C and 1040 tax returns each year. If any money is left in the company's account, income tax must be paid for that money.  

State Taxes and Fees for LLCs

Even though LLCs benefit from federal pass-through treatment, states may impose their own taxes, fees, or filing obligations. These can include:

  • Annual franchise taxes or flat fees, regardless of profitability.
  • Gross receipts taxes, which are based on revenue rather than net income.
  • State income taxes on each member’s share of LLC profits.

For example, California imposes an annual LLC tax and an additional fee based on total income, while other states may have minimal charges or none at all. It’s important for LLC owners to review state-specific requirements to avoid penalties and ensure compliance.

Qualified Business Income (QBI) Deduction

Many LLC members qualify for the 20% Qualified Business Income deduction under Section 199A of the Internal Revenue Code. This allows eligible owners of pass-through entities to deduct up to 20% of their qualified business income from taxable income, subject to certain income thresholds and restrictions.

This deduction can significantly lower the effective tax rate for LLC members, but it is phased out for certain high-income taxpayers, especially those in specified service trades or businesses. Proper planning with a tax professional can help maximize the benefit.

Frequently Asked Questions

1. What is an LLC pass through?

It’s a tax structure where profits and losses pass directly to LLC members’ personal tax returns, avoiding federal corporate income tax.

2. Do all LLCs have pass-through taxation?

By default, yes. However, LLCs can elect S corporation or C corporation status, which changes their tax treatment.

3. Do LLC members pay self-employment tax?

Generally, yes—unless the LLC elects S corporation status and some income is taken as distributions rather than salary.

4. Are LLC pass-through earnings taxed in every state?

Not always. Some states impose income tax, while others levy annual fees or franchise taxes regardless of income.

5. Can LLC members take the Qualified Business Income deduction?

Yes, many pass-through LLC owners qualify for up to a 20% QBI deduction, subject to income and business type limits.

If you need help with an LLC pass through, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.