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Tax Reform Questions: What is a pass-through business entity?

If you are a small business owner or planning to become one, you likely have seen some mention in the news about the GOP tax law changes for small businesses. One of the most talked about changes is the pass-through deduction. This deduction is intended to benefit pass-through business entities such as sole proprietorships, LLCs, S-corps, and partnerships. These types of businesses do not file tax returns as a corporation but rather “pass-through” business profits and losses through their individual tax returns.

You may be wondering if your business qualifies for this tax advantage or if you should form a business that will. In most cases, small businesses who do not operate in excluded industries and who also do not go over maximum income thresholds could qualify. Figuring out what industries or services are excluded can be complicated, so if you have any questions about whether your business qualifies, you should ask a tax lawyer. Projecting whether your business fits within the threshold can also be estimated by a CPA or an accountant.

For more reasons than this tax law change, if you are a sole proprietor or are self-employed, you may benefit from forming a legal business entity. If you are planning on starting a new business, talk to a lawyer about which type of pass-through business entity best suits your business.

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Types of business entities

Here are the four types of pass-through entities briefly explained:

Sole Proprietorships

These are unincorporated businesses owned by one person. It is not an actual legal business entity and offers no personal liability protection.

Limited Liability Corporations (LLCs)

This is a popular business entity formed by one or more members. If you form this type of entity, members of the company are not held personally liable for business debt or liability (in most cases).

S Corporations (S-corps)

S-corps are made up of one or more members who share the company’s profits, losses, deductions, and credits. The shareholders pass-through business profits and losses through their individual tax returns.


Partnerships can consist of two or more people. Profits and liability are shared, but it may not be shared equally. Categories include general, limited liability and limited partnerships.

What is the pass-through deduction?

Explained in the simplest of terms, the pass-through deduction offers qualified businesses the opportunity to deduct 20 percent from their pass-through income. But, there additional factors that need to be considered such as exclusions, thresholds, and qualifying business income and property. Figuring out how this deduction may benefit your business can be confusing and you should contact a tax lawyer or accountant about your exact tax situation.

Ready to start your new business?

Once you have figured out what business entity to form, Rocket Lawyer can help you with the process, regardless of what state you live in. We can also help you obtain your Employer Identification Number (EIN) and provide ongoing compliance support.

If you are not sure what type of business entity best fits your business, you can begin by trying our business structure quiz. You can also benefit from talking to our incorporation specialists or asking a lawyer a question.

This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.

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