Pass-Through Taxation vs. Double Taxation

Some types of business entities (such as partnerships and LLCs) are subject to pass-through taxation. This means that the net income from the business flows through to the owners' individual taxable incomes. The owners would then report their share of the business income as part of their IRS Form 1040 and other forms. Thus, the business income will be taxed only once at each owner's personal tax rate. Owners with higher total personal income will be taxed at a higher rate than owners with a lower total personal income. Note that the owners of a partnership are called partners, and the owners of an LLC are called members.

By contrast, certain other types of business entities (such as C-corporations) are subject to double taxation. This means that the net income from the business will be taxed twice. The first layer of tax is at the corporate level: the business itself will need to pay corporate tax on its net income. The second layer of tax is at the individual owner level: when the business distributes some of its net income to owners in the form of dividends, the owners who receive these dividends will need to pay taxes on the dividends as part of their individual taxable income. Note that the owners of a corporation are called shareholders.

By default, LLCs are subject to pass-through taxation, but the LLC's members can elect to switch to a double taxation scheme.

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