question.jpgIn Business Law

What is pass-through taxation?

Pass-through taxation is the type of taxation which generally applies to partnerships. This means that the partnership, itself, is not directly taxed, and the tax burden is instead passed on to the partners. Thus, the partnership pays its profit earnings to the partners as income, wages and profit payments, and each partner pays the taxes on their individual share of those profits. Similarly, if the partnership took a loss for the year, each partner can deduct their share of that loss from their personal tax return.

This is the same type of taxation that applies to a sole proprietorship, and to most limited liability companies (unless they elect to be subject to the double taxation that generally applies to corporations). This pass-through taxation is particularly advantageous for smaller businesses because (a) the final tax burden may be less then it would be with double taxation and (b) it is often easier to handle.

You should be aware that the partnership itself must still file a tax return, even though it has no tax burden. This return has to indicate the partnership’s finances for the past year, showing how much the partnership made or lost. It also must show how the profits and losses are attributed to each partner, and to the extent any profits were paid, the return must indicate what profits were paid to which partners, and when they were paid.