By GreenGrowth CPAs Tax Team · Updated October 2026 · Tax
A pass-through entity is a business that generally pays no federal income tax itself. Its profits and losses flow through to the owners, who report them on personal returns and pay tax at individual rates.
Partnerships, most LLCs, S corporations, and sole proprietorships all work this way. That structure shapes how owners pay self-employment tax, claim the QBI deduction, and use state PTE elections to work around the federal SALT cap.
QUICK ANSWER
A pass-through entity (PTE) is a business whose income is taxed on its owners' returns, not at the entity level. Partnerships, multi-member LLCs, S corporations, and sole proprietorships qualify. Owners receive a Schedule K-1 (or report on Schedule C) and may claim the 20% QBI deduction, now permanent. Most states also let partnerships and S corporations elect to pay state tax at the entity level, a workaround to the federal SALT cap of $40,400 for 2026.
Pass-Through Entities: At a Glance
- What PTE means: Pass-through entity. Income passes to owners and is taxed once, on their returns.
- Who qualifies: Sole proprietorships, partnerships, LLCs taxed as either, and S corporations. C corporations do not.
- Owner reporting: Partners and S corporation shareholders receive Schedule K-1 each year.
- QBI deduction: Up to 20% of qualified business income, made permanent by the 2025 tax law.
- SALT cap for 2026: $40,400, reduced for MAGI above $505,000 but never below $10,000.
- PTE elections: A state level choice to pay income tax at the entity level, which sidesteps the SALT cap for owners.
What Qualifies as a Pass-Through Entity?
Federal tax law treats several business forms as pass-throughs. The label depends on how the entity is taxed, not what it is called under state law.
- Sole proprietorships: The owner reports business income on Schedule C with no separate entity return.
- Partnerships: General partnerships, limited partnerships, and LLPs file Form 1065 and issue K-1s to partners.
- LLCs: A multi-member LLC is taxed as a partnership by default. A single-member LLC is disregarded and reported on the owner's return. Either can elect corporate treatment instead.
- S corporations: A corporation or LLC that makes an S election files Form 1120-S and passes income to shareholders.
A C corporation is the main exception. It pays corporate tax on profits, and shareholders pay tax again on dividends. For LLC choices in more detail, see our guide to LLC taxes.
▶ Common Pass-Through Entities
| Entity | Federal return | Owner reporting | Self-employment tax |
|---|---|---|---|
| Sole proprietorship | None (owner's Form 1040) | Schedule C | Yes, on net earnings |
| Single-member LLC | None by default (disregarded) | Schedule C or E | Yes, if active business |
| Partnership or multi-member LLC | Form 1065 | Schedule K-1 | General partners yes; limited partners mostly no |
| S corporation | Form 1120-S | Schedule K-1 | No on K-1 income; wages subject to payroll tax |
How Pass-Through Income Flows to Owners
A partnership or S corporation computes its income, then allocates each owner a share. That share appears on Schedule K-1. Owners pay tax on their share whether or not the business distributed any cash.
K-1 Mechanics
Partnerships allocate items under the partnership agreement. S corporations allocate strictly by share ownership, one class of stock, pro rata. Returns for calendar year partnerships and S corporations are due March 15. A late K-1 often forces owners to extend their personal returns.
Self-Employment Tax for Partners
General partners generally owe self-employment tax on their distributive share of trade or business income. Limited partners usually owe it only on guaranteed payments for services. S corporation shareholders do not pay self-employment tax on K-1 income. Instead, owner employees must take a reasonable salary subject to payroll tax. Our post on S corp reasonable compensation explains how to set it.
The QBI Deduction After the 2025 Tax Law
Section 199A lets owners of pass-through businesses deduct up to 20% of qualified business income. The deduction was scheduled to expire after 2025. The One Big Beautiful Bill Act, signed July 4, 2025, made it permanent at 20%.
For 2026, wage and property limits and specified service business rules start to apply above taxable income of $201,750, or $403,500 for joint filers. They phase in fully at $276,750 and $553,500. The 2025 law also adds a minimum deduction of $400 starting in 2026. It applies to owners with at least $1,000 of QBI from active businesses in which they materially participate.
Paying more than $40,400 in state income tax through a partnership or S corp? A PTE election may cut your federal bill.
Book a Consultation →State PTE Elections: The SALT Cap Workaround
For many owners, the PTE election is now the most valuable planning tool tied to a pass-through structure. It turns state income tax into a business deduction that the SALT cap does not reach.
SALT Cap Background
The 2017 tax law capped the individual deduction for state and local taxes at $10,000. The 2025 law raised the cap to $40,000 for 2025 and $40,400 for 2026, with 1% annual increases through 2029. In 2030 it drops back to $10,000.
Higher earners lose part of the increase. The cap shrinks by 30% of modified AGI above $505,000 for 2026, but never below $10,000. At about $606,000 of MAGI, a 2026 filer is back to the $10,000 floor. Our post on the 2026 SALT deduction runs through the phase-down math.
▶ Federal SALT Cap After the 2025 Law
| Tax year | Cap (MFS: half) | MAGI phase-down threshold |
|---|---|---|
| 2018 to 2024 | $10,000 | None |
| 2025 | $40,000 | $500,000 |
| 2026 | $40,400 | $505,000 |
| 2027 to 2029 | Prior year plus 1% | Prior year plus 1% |
| 2030 and later | $10,000 | None |
How PTE Works
IRS Notice 2020-75 announced that state and local income taxes imposed on and paid by a partnership or S corporation are deductible by the entity. That includes taxes paid under an elective regime. The deduction lowers the income on each owner's K-1, and it never touches the owner's personal SALT cap. The state then gives owners a credit or exclusion for the entity level tax.
A side effect matters here. The entity deduction lowers ordinary business income, which can also reduce each owner's QBI deduction. Model both effects before you elect.
Did the 2025 Law Restrict PTE Elections?
No. Drafts of the bill in both the House and the Senate would have limited the PTE deduction for certain owners, including many service businesses. Congress dropped those limits from the final law. The SALT cap provision in Section 164(b) contains no restriction on entity level taxes, so the Notice 2020-75 treatment still applies as of 2026.
States That Allow PTE Elections
Most states with a personal income tax now offer some version of the election. The rules differ widely. New York requires an online election each year by March 15. California extended its elective tax through 2030. Starting in 2026, missing the June 15 prepayment there reduces the owners' credit instead of voiding the election, as our post on California PTET and the June 15 payment explains.
Who Benefits Most
- High earners in high tax states: Their state tax far exceeds the cap, especially once the phase-down applies.
- Standard deduction filers: The entity deduction works even if the owner does not itemize.
- Single state businesses: Owners who all live in the electing state get the cleanest credit.
Watch for owners who live in other states, businesses with losses, and cash flow strain from entity level estimates.
How to Make the Election
Check eligibility in each state where the business files. Confirm which owners can participate, then model federal savings against state credit limits. Next, calendar the election deadline and any prepayment date. Last, update the operating agreement so electing owners bear the tax cost fairly. Our state and local tax team handles multi-state elections.
KEY TAKEAWAYS
- ›A pass-through entity pays no federal income tax itself. Owners report their share on personal returns.
- ›Partnerships, multi-member LLCs, and S corporations issue Schedule K-1. Owners owe tax whether or not cash is distributed.
- ›The 20% QBI deduction is permanent after the 2025 law, with a new $400 minimum starting in 2026.
- ›The SALT cap is $40,400 for 2026 and phases down above $505,000 of MAGI, never below $10,000.
- ›State PTE elections survived the 2025 law and remain the main workaround to the SALT cap.
Frequently Asked Questions
Yes. A partnership files Form 1065 but generally pays no federal income tax itself. Each partner reports a share of income, deductions, and credits from Schedule K-1 on a personal return. Multi-member LLCs are taxed as partnerships by default, so they are pass-through entities too. The main exception sits at the state level. Some states impose entity level taxes, and many let partnerships elect to pay state income tax at the entity level.
Schedule K-1 is the form a pass-through entity sends each owner to report that owner's share of the year's income, deductions, credits, and other items. Partnerships issue it with Form 1065, and S corporations issue it with Form 1120-S. The owner uses it to complete a personal return. You owe tax on K-1 income whether or not the business distributed any cash to you, so plan for the liability.
PTE stands for pass-through entity. It describes a business whose profits and losses pass through to its owners' individual tax returns instead of being taxed at the entity level. Partnerships, most LLCs, S corporations, and sole proprietorships are common examples. In tax conversations, PTE also shows up in PTET, the elective pass-through entity tax that many states offer as a workaround to the federal SALT deduction cap.
A PTE election is a state level choice by a partnership or S corporation to pay state income tax at the entity level on behalf of its owners. The entity deducts that tax on its federal return, which lowers the income passed through to owners. Owners then receive a state credit or exclusion for the tax paid. Each state sets its own deadlines, eligibility rules, and payment requirements, and most require a new election every year.
Individuals can deduct state and local taxes only up to the SALT cap, which is $40,400 for 2026 and phases down for higher incomes. IRS Notice 2020-75 confirmed that income tax imposed on and paid by a partnership or S corporation is deductible by the entity. That deduction reduces the owners' share of federal taxable income and never counts against their personal cap. The owners then claim a state credit for the entity level tax.
Owners whose state income tax exceeds their SALT cap benefit most. That group includes high earners in high tax states, especially those with income above the $505,000 phase-down threshold for 2026, whose cap can shrink to $10,000. Owners who take the standard deduction also gain, because the entity deduction works even when they do not itemize. The math is less favorable for owners in states with weak credits or for businesses with losses.
Where to Go From Here
Find Out What a PTE Election Is Worth to You
We model entity structure, QBI, and state PTE elections together, so owners see the full federal and state picture before deadlines hit.
KEY NUMBERS
The Right Entity Structure Pays Off Every Tax Year.
Book a free consultation. We will review your pass-through structure, test a PTE election, and map the deadlines in every state you file.
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