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Some Pass-Through Businesses are Significant Employers

2 min readBy: Kyle Pomerleau

In the United States, most businesses are not C corporations. 95 percent of businesses are what are called pass-through businesses. These businesses are called pass-throughs because their income is passed directly to their owners, who then need to pay individual income taxes on it. Contrast this with C corporations that need to pay the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. on its income before it passes its earnings to its owners. Combined, pass-through businesses employ 55 percent of all private-sector workers and pay nearly 40 percent of all private-sector payroll.

When talking about pass-through businesses it is tempting to equate them to small businesses. In a way, the characterization isn’t totally wrong. C corporations are much larger than pass-through businesses. However, one must be careful when describing pass-through businesses as small: not all of them fit that description. In fact, many pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. firms employ thousands of workers each.

Most pass-through employment is either self-employment (33.6 percent) or at small firms with between 1 and 100 employees (38.7 percent). However, a significant number of employees work at large pass-through businesses. According to 2011 Census data, a combined 27.5 percent (18.1 million) of pass-through employment was at firms with more than 100 employees, and 15.9 percent (10.3 million) of pass-through employees work at large firms with 500 or more employees.

In contrast, employment at C corporations is heavily concentrated in large firms. In 2011, 72.3 percent (38 million) of C corporate workers were employed at large firms with 500 or more employees with an additional 8.9 percent (4.7 million) working at firms with between 100 and 500 employees. The remaining 18.7 percent (9.9 million) of corporate employment was at firms with fewer than 100 employees.

Not recognizing the fact that pass-through businesses can be large employers can bring about poor policy choices. For example, increases in the top marginal individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate will not only hit individuals with high wage income or business income, it may hit a significant number of large employers who are organized as pass-through businesses. Conversely, some policies that are aimed at helping small businesses, such as state-level pass-through business income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. exemptions, could incidentally benefit large established businesses.

For more on pass-through businesses see here.