The majority of U.S. businesses — sole proprietorships, partnerships, S-Corporations, and most LLCs — are “pass-through entities.” That means the business itself doesn’t pay federal income tax. Instead, business income passes through to the owners’ personal tax returns, where it’s taxed at individual rates.
Understanding how pass-through taxation works — and how to optimize it — is foundational to running a tax-efficient business. FJ & Associates, PLLC helps Utah business owners navigate the rules, make entity structure decisions, and build tax strategies that work with pass-through taxation rather than around it.
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The Four Pass-Through Entity Types
Sole Proprietorship
The simplest form of business ownership. All business income and expenses are reported on Schedule C (Form 1040). Net income is subject to both income tax and self-employment tax. No separation between business and personal liability.
Single-Member LLC (SMLLC)
Taxed identically to a sole proprietorship by default — Schedule C, SE tax, no corporate return. Provides liability protection but no tax differentiation from a sole proprietor unless an entity election is made.
Partnership / Multi-Member LLC
Partnerships and multi-member LLCs file Form 1065 and issue Schedule K-1 to each partner reflecting their share of income, deductions, and credits. Partners pay income tax (and generally SE tax on their distributive share of ordinary income) on their personal returns. The partnership itself pays no federal income tax.
S-Corporation
S-Corps file Form 1120-S and issue Schedule K-1 to shareholders. Income passes through to shareholders’ personal returns and is taxed at individual rates — but distributions are not subject to self-employment/FICA tax, unlike sole proprietor or partnership income. Owner-employees must receive a reasonable salary, which is subject to FICA. See our self-employment tax guide for the SE tax implications.
How Pass-Through Income Is Taxed at the Individual Level
Pass-through income is added to the owner’s other income (wages, investment income, etc.) on their personal return and taxed at the applicable marginal rate — 10%, 12%, 22%, 24%, 32%, 35%, or 37% for federal purposes in 2024, plus Utah’s 4.65% flat individual income tax rate.
Key point: Pass-through income is not passive income by default. Business owners who materially participate in their business report the income as active — it’s not sheltered by passive loss rules, and it generally is subject to SE tax (for sole proprietors and general partners) or FICA (for S-Corp owner-employees on wages).
The Qualified Business Income (QBI) Deduction
IRC Section 199A allows pass-through business owners to deduct up to 20% of their qualified business income (QBI) from their taxable income. This deduction was introduced by the Tax Cuts and Jobs Act to partly equalize the treatment of pass-through businesses and C-Corporations (which received a rate cut to 21%).
Limitations on the QBI deduction:
- W-2 wage limitation: For high-income taxpayers, the deduction is limited to the greater of 50% of W-2 wages paid by the business, or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property
- SSTB limitation: Specified service trades or businesses — including law, accounting, health, financial services, and consulting — phase out of QBI eligibility above $191,950 (single) or $383,900 (married) in 2024 taxable income
- Aggregation rules: Owners with multiple businesses may aggregate qualifying businesses to maximize the deduction
QBI interaction with S-Corp salary level is a critical planning point — higher salary reduces QBI available for the deduction. We model the optimal salary/QBI combination for each client.
Utah Pass-Through Entity Tax Election
Utah enacted a Pass-Through Entity (PTE) tax election that allows eligible pass-through entities to pay Utah state income tax at the entity level. This provides a federal deduction for the state taxes paid — effectively a workaround for the $10,000 SALT deduction cap for individual owners.
How it works:
- The pass-through entity pays Utah income tax at the 4.65% rate on the owners’ distributive shares
- The entity-level tax is deductible as a business expense on the entity’s federal return — no SALT cap applies to business expense deductions
- Individual owners receive a credit on their Utah returns for the state tax paid at the entity level
For Utah S-Corp and partnership owners with significant Utah income, the PTE election often produces meaningful federal tax savings. We model the impact for each client before recommending the election.
Pass-Through Losses and At-Risk/Passive Activity Rules
When a pass-through entity produces a loss, the loss passes through to owners — but two sets of rules limit how and when it can be used:
- At-risk rules (IRC §465): Losses are deductible only to the extent of the owner’s “at-risk” amount — generally their cash investment plus their share of recourse debt. Losses in excess of at-risk basis are suspended.
- Passive activity rules (IRC §469): If the owner doesn’t materially participate in the business, losses are “passive” and can only offset passive income. Passive losses from rental real estate and non-participating investments cannot offset active business income or wages.
These rules create planning opportunities — particularly for real estate investors who may qualify as real estate professionals and for S-Corp owners who can manage their basis through additional capital contributions before year-end.
Pass-Through Tax FAQs
What’s the difference between a partnership K-1 and an S-Corp K-1?
Both report your share of the entity’s income, deductions, and credits. The key difference: partnership K-1 income generally carries SE tax for general partners; S-Corp K-1 income does not (only W-2 wages from the S-Corp are subject to FICA). This is the primary driver of the SE tax advantage in the S-Corp structure.
Can I change my LLC from pass-through to C-Corp taxation?
Yes. An LLC can elect to be taxed as a C-Corp by filing Form 8832. This may be advantageous if you’re retaining significant earnings for reinvestment, need access to C-Corp-exclusive fringe benefits, or are planning a venture capital raise that requires a C-Corp structure. We advise on the conversion implications.
Does Utah recognize S-Corp status?
Yes. Utah follows federal S-Corp status and taxes S-Corp income at the individual level. Utah also offers the PTE election (see above) as an additional planning tool for Utah S-Corp owners.
How does pass-through taxation affect my ability to deduct losses from my investment in the business?
Your ability to deduct losses depends on your basis in the entity, your at-risk amount, and whether the activity is passive or active. S-Corp shareholders can only deduct losses up to their stock and debt basis. Partners can use their outside basis in the partnership interest. We track basis each year and advise on strategies to maintain deductibility of future losses.
Get Clear on Your Pass-Through Tax Situation
Understanding how your business is taxed — and whether it’s optimized — is the foundation of every other tax planning decision you make. Let’s start there.
📞 (801) 927-1337
✉ admin@cpaone.net
📍 612 N Kays Dr Suite 120, Kaysville, UT 84037
Schedule a Pass-Through Tax Consultation →
See also: Self-Employment Tax Strategies | Advanced Tax Planning | Utah Business Tax Services
Missy Dennis, CPA | Partner | FJ & Associates, PLLC | Kaysville, Utah. Missy holds a Master of Accounting degree from the University of Utah and is a licensed Certified Public Accountant. She is committed to providing clear, accurate, and actionable guidance so clients can navigate complex financial decisions with confidence. With more than twenty years of public accounting experience, Missy Dennis specializes in: Tax preparation and tax advisory; Bookkeeping strategy alignment; Estate and trust taxation; Audit and consulting services; Low-income housing tax credits; Non-profit accounting; Small- and mid-sized business advisory.
