Definition
Business profit that is not taxed at the business level but passes through to the owners' personal tax returns, where it is taxed at their individual rates. Sole proprietorships, partnerships, most LLCs, and S corporations all work this way, in contrast to a C corporation, which pays its own corporate tax before distributing dividends that are taxed again.
Why it matters
Pass-through owners owe tax on their share of profit whether or not the business actually paid it out, which can mean a tax bill with no cash to pay it. The structure also determines whether profit is hit by self-employment tax and whether it qualifies for the qualified business income deduction.
Example
Three partners own an LLC that earns $300,000 and keeps $150,000 in the business to buy equipment. The LLC pays no income tax itself; each partner receives a K-1 showing $100,000 of income and reports it on her personal return, even though each actually received only $50,000 in cash.
Put it into practice
Related terms
This definition is educational, not financial, legal, or tax advice. U.S. rules and limits change; verify time-sensitive details with official sources. See our disclaimer.