Pass-Through Entity
A pass-through entity is a business whose profits and losses land on the owners' personal tax returns instead of being taxed at the business level — sole proprietorships, partnerships, most LLCs, and S corporations.
Roughly 95% of US businesses are pass-throughs, and the appeal is simple: the income gets taxed once, on your 1040, not twice the way a C corporation's does. The entity still files a return — Form 1065 for a partnership, 1120-S for an S corp — but that return is informational. It reports who earned what and hands each owner a K-1; the entity itself writes no income-tax check.
The number that makes this structure worth understanding is the Section 199A qualified business income deduction. You can deduct up to 20% of your pass-through income, which drops the top effective federal rate from 37% to 29.6%. That deduction used to be scheduled to sunset after 2025. The One Big Beautiful Bill Act, signed in July 2025, made it permanent — so you can finally plan around it instead of betting on what Congress does next.
Two things changed for 2026. First, the income range over which the deduction phases out for service businesses got wider: the limits now start biting at $201,775 of taxable income for single filers and $403,500 for joint filers, and phase in over a $75,000 band for singles and a $150,000 band for couples. Second, OBBBA added a floor — if your QBI tops $1,000, you get at least a $400 deduction even when the percentage math would give you less. Past those thresholds, whether you run a "specified service trade or business" (law, accounting, consulting, health) starts to matter, because that's where the deduction begins to shrink.
Losses flow through too, but you can't always use them all at once. The at-risk and passive-activity rules come first, and then the excess business loss cap. For 2026 that cap tightened: you can deduct business losses against non-business income only up to $256,000 single, $512,000 joint — down from $313,000 and $626,000 in 2025, because OBBBA reset the inflation math and made the limit permanent. Anything over the cap carries forward as a net operating loss.
None of this makes pass-through the automatic right answer. A C corporation pays a flat 21% and shields retained earnings from your personal rate, so if you're plowing profit back into the business rather than paying yourself, the second layer of tax you'd eventually owe on dividends may still beat handing 29.6% to the IRS every year. The call turns on how much you earn, how fast you're growing, and how much cash actually leaves the business. Run both before you elect.
Practical Example
A two-partner partnership earns $400,000 in 2026. The partnership owes no income tax; it issues a K-1 to each partner for $200,000. Both partners are under the $403,500 joint phase-in threshold, so each takes the full 20% QBI deduction — $40,000 — leaving $160,000 of taxable business income before any other deductions.