Pass-through Entities (Claimant/Taxpayer)

A pass-through entity is a legal business structure where tax attributes such as income and credits flow directly to its owners, who then claim the Utah research and development tax credit as individual claimants or corporate taxpayers. This statutory mechanism ensures that the state’s financial incentives for innovation offset the personal or corporate income tax liabilities of the stakeholders responsible for funding Utah-based research.

Conceptual and Legal Framework of Pass-through Entities

The designation of a pass-through entity within the Utah tax system is inextricably linked to federal classifications under the Internal Revenue Code. According to Utah Code Section 59-10-1402, a pass-through entity is defined as a business entity that is classified as a partnership or an S-corporation for federal income tax purposes. This definition further encompasses estates and trusts where income, gain, loss, deduction, or credit is divided among and passed through to one or more pass-through entity taxpayers. The defining characteristic of these entities is their transparent nature; they generally do not incur a tax liability at the entity level but instead serve as conduits for the transmission of tax attributes to their constituent members.

The terminology governing the participants in this system is precise and carries distinct legal implications for the claiming of research credits. A pass-through entity taxpayer refers to any resident or nonresident individual, resident or nonresident business entity, or resident or nonresident estate or trust that holds an interest in a pass-through entity. Specifically, this includes partners in a general partnership, members of a limited liability company, partners in a limited liability partnership or limited partnership, shareholders in an S-corporation, and beneficiaries of qualifying estates or trusts. Within this hierarchy, Utah law identifies a final pass-through entity taxpayer as a resident or nonresident individual, explicitly excluding business entities, estates, or trusts from this final tier. This distinction is vital for determining the ultimate application of the research tax credit and the management of withholding obligations.

Terminology	Legal Definition	Statutory Reference
Pass-through Entity (PTE)	Partnership, S-corp, or LLC classified as such for federal tax purposes.	§ 59-10-1402(11)
PTE Taxpayer	A resident or nonresident individual, business entity, or estate/trust receiving pass-through items.	§ 59-10-1402(12)
Final PTE Taxpayer	A resident or nonresident individual (natural person).	§ 59-10-1402(7)
Claimant	A resident or nonresident person with state taxable income.	§ 59-10-1002(1)
Taxpayer	Any individual, estate, trust, beneficiary, or entity subject to tax.	§ 59-10-103(1)(aa)

The Research and Development (R&D) credit in Utah, officially known as the Tax Credit for Increasing Research Activities, functions within this framework by allowing the entity to calculate the credit based on its qualified research expenses while the individual partners or corporate owners realize the tax benefit. The character of the credit is determined at the entity level and remains constant when it is allocated to the owners. Consequently, if a partnership performs research that qualifies under the technological standards of the law, the resulting credit retains its nonrefundable and carryforward-eligible status as it passes to each partner’s individual tax return.

Statutory Foundation of the Research Activities Credit

The Utah research activities credit is governed by two parallel tracks within the state code, ensuring that both corporate and individual taxpayers have access to the incentive. For C-corporations, the credit is authorized under Section 59-7-612. For individuals, estates, and trusts—which includes the vast majority of owners of pass-through entities—the credit is authorized under Section 59-10-1012. Although residing in different chapters of the Revenue and Taxation title, these statutes are effectively mirrors of one another, utilizing identical definitions and calculation methodologies heavily rooted in Section 41 of the Internal Revenue Code (IRC).

Utah law provides three distinct components that comprise the total research activities credit. First, a taxpayer may claim a credit equal to 5% of their qualified research expenses for the current taxable year that exceed a base amount. Second, a credit of 5% is available for certain payments made to a qualified organization for basic research that exceed a base amount. Third, an additional credit is allowed equal to 7.5% of the taxpayer’s total qualified research expenses for the current taxable year, regardless of any base amount. This three-component structure is designed to reward both the absolute volume of research conducted in the state and the incremental growth of research investments over time.

The primary requirement for all three components is that the research must be conducted within the state of Utah. While Utah adopts the federal definitions of “qualified research” and “qualified research expenses,” it imposes a strict geographic limitation. Only in-house research expenses incurred in Utah and contract research expenses for activities performed in Utah may be included in the calculation. This geographic nexus is fundamental to the legislative intent of fostering local economic growth and technological infrastructure.

Calculation Methodology and the Role of IRC Section 41

Utah’s research tax credit is intentionally aligned with the federal credit for increasing research activities provided in Section 41 of the Internal Revenue Code. This alignment minimizes the administrative burden on taxpayers by allowing them to utilize the same data gathered for federal compliance, with adjustments for Utah-specific source rules. Section 59-10-1012 explicitly states that the credits shall be calculated as provided in Section 41 of the Internal Revenue Code and that federal definitions apply.

The “base amount” calculation for the 5% incremental credit is one of the more complex aspects of the law. Under Section 41(c) of the IRC, the base amount is generally the product of a fixed-base percentage and the average annual gross receipts of the taxpayer for the four taxable years preceding the current year. In the Utah context, “gross receipts” are defined as only those gross receipts attributable to sources within this state, as determined by the state’s allocation and apportionment provisions under the Uniform Division of Income for Tax Purposes Act (UDITPA). This ensures that the base amount reflects a taxpayer’s historical Utah economic footprint rather than its global revenue.

The Component Breakdown

The total credit is the sum of three separate calculations, each with different rules for carryforward and application. The first two components focus on incremental growth, while the third focuses on the total volume of current-year spending.

Credit Component	Statutory Rate	Base Calculation	Carryforward Period
Incremental QRE Credit	5%	Current QREs minus Utah Base Amount	14 Years
Basic Research Credit	5%	Payments to Utah Orgs minus Base Amount	14 Years
Volume Credit	7.5%	Total Current Utah QREs	None

The nonrefundable nature of the credit means it can only reduce a taxpayer’s Utah income tax liability to zero; it cannot result in a payment from the state. For the incremental and basic research components, any credit exceeding the current year’s tax liability may be carried forward for a period of up to 14 years. This carryforward provision is particularly significant for businesses in the early stages of product development that may incur heavy research costs years before they achieve profitability and significant tax liability. Conversely, the 7.5% volume credit must be used in the year it is generated, or it is lost.

Base Amount Formulas and Calculations

The base amount is mathematically represented by the following relationship derived from federal and state statutes:

Base Amount = Fixed-Base Percentage × Avg. Utah Gross Receipts (Years n-1 to n-4)

Where the fixed-base percentage is determined by the ratio of the taxpayer’s aggregate qualified research expenses to aggregate gross receipts for a specified historical period, capped at a maximum of 16%. For companies that do not have a historical presence in Utah, the base amount is often set at a minimum of 50% of the current-year qualified research expenses, as provided by federal “startup” and “base amount” limitations adopted by the state.

The Startup Election and Its Irrevocability

Recognizing the unique challenges faced by new ventures, Utah Code allows a taxpayer to elect to be treated as a “start-up company” for the purpose of calculating the base amount. This election is available regardless of whether the taxpayer meets the strict requirements for startup status under Section 41(c)(3)(B) of the Internal Revenue Code. This is a significant departure from federal rules, as it allows established companies moving into the state or diversifying into new research areas in Utah to benefit from the startup calculation.

Once a taxpayer makes the election to be treated as a startup company under Utah law, the election is irrevocable. For a startup, the fixed-base percentage is set at 3% for each of the taxpayer’s first five taxable years in which it has both qualified research expenses and gross receipts. Beginning in the sixth year, the fixed-base percentage is phased in over a multi-year period based on a fraction of the company’s actual historical ratio of QREs to gross receipts.

Taxable Year	Fixed-Base Percentage Phase-In
Years 1–5	3.0% (Statutory Fixed Rate)
Year 6	1/6 of aggregate QREs / aggregate Gross Receipts
Year 7	1/3 of aggregate QREs / aggregate Gross Receipts
Year 8	1/2 of aggregate QREs / aggregate Gross Receipts
Year 9	2/3 of aggregate QREs / aggregate Gross Receipts
Year 10	5/6 of aggregate QREs / aggregate Gross Receipts
Year 11+	100% of aggregate QREs / aggregate Gross Receipts

The use of Utah-only gross receipts in this calculation is a critical protection for taxpayers. If a company has massive global gross receipts but only a small presence in Utah, using global receipts would lead to a disproportionately high base amount, effectively eliminating the incremental credit. By limiting the calculation to Utah sources, the law ensures the credit remains accessible and incentivizes the expansion of local research teams.

Defining Qualified Research Expenses (QREs)

The determination of what constitutes a “qualified research expense” (QRE) is the cornerstone of any research credit claim. Utah adopts the federal definitions found in IRC Section 41(b), which divides QREs into two primary categories: in-house research expenses and contract research expenses.

In-house research expenses include wages paid to employees for “qualified services,” the cost of supplies used in the conduct of qualified research, and amounts paid to another person for the right to use computers in the conduct of research. Qualified services generally include the actual performance of research, as well as the direct supervision or direct support of research activities. It is important to note that “wages” in this context refers to the definition provided in IRC Section 3401(a), which includes all remuneration for services performed by an employee for their employer.

Contract research expenses are defined as 65% of any amount paid or incurred by the taxpayer to any person (other than an employee) for qualified research. A higher rate of 75% applies if the payments are made to a qualified research consortium. In the Utah context, all such payments must be for research conducted within the state to be included in the calculation of the credit.

The Four-Part Test for Qualified Research

To qualify as “qualified research,” the activity must meet the four-part test established by the federal government and fully adopted by the Utah State Tax Commission. This test is used during audits to distinguish between routine business activities and the type of scientific advancement the credit is intended to reward.

Technological in Nature: The research must fundamentally rely on the principles of physical or biological science, engineering, or computer science.

Permitted Purpose: The research must be intended to develop a new or improved business component’s function, performance, reliability, or quality.

Elimination of Uncertainty: The activity must be intended to discover information that would eliminate technical uncertainty concerning the development or improvement of a product or process.

Process of Experimentation: Substantially all of the activities must constitute a process of experimentation, involving the evaluation of one or more alternatives through modeling, simulation, or systematic trial and error.

Activities that are specifically excluded from the definition of qualified research include research conducted after the beginning of commercial production, research related to the adaptation of an existing business component, and research involving the social sciences or humanities. Furthermore, routine data collection and market research are not eligible.

Pass-through Entity Reporting and Allocation

The reporting of the research activities credit by a pass-through entity involves a multi-step process that ensures the credit is properly documented at the entity level and accurately allocated to each partner or shareholder. The entity itself does not “claim” the credit to offset its own tax, as pass-through entities generally do not have a tax liability. Instead, the credit is treated as a “separately stated item” that passes through to the owners.

The process begins on the entity’s Utah return—Form TC-65 for partnerships and LLCs, or Form TC-20S for S-corporations. The total credit calculated by the entity is reported on Schedule K (Partners’ Distribution Share Items) on Line 17. The entity must describe the credit as the “Credit for Increasing Research Activities in Utah” and use the state-assigned code 12.

Allocation to Partners and Schedule K-1

Once the total credit is reported on Schedule K, it must be allocated to each partner or shareholder. This allocation is typically done on a pro-rata basis according to the ownership percentages reported on the federal return. However, the determination of whether a pass-through entity taxpayer is considered a partner, member, or shareholder for these purposes is made in accordance with applicable state law governing the entity.

Each owner is provided with a Utah Schedule K-1, which lists their specific share of the credit in the “Other Information” or “Nonrefundable Credits” section. The partner then uses this amount to claim the credit on their own Utah income tax return. For individuals, the credit is entered on Form TC-40A, Part 4, using code 12. It is a critical requirement that the partnership provides the Schedule K-1 to each partner, as this document serves as the primary evidence of the partner’s right to claim the credit.

Form Type	Entity Type	Credit Reporting Location
TC-65	Partnership / LLC	Schedule K, Line 17 (Code 12)
TC-20S	S-Corporation	Schedule K, Line 15 (Code 12)
TC-250	All PTEs	Reconciliation of Credits from Upper Tiers
TC-40A	Individual Owners	Part 4 (Code 12)
TC-20	Corporate Owners	Schedule AC (Code 12)

Treatment of Tiered Partnerships and Form TC-250

In complex business structures where one pass-through entity owns an interest in another (a “tiered” partnership), the law provides a mechanism for the credit to flow through multiple levels of ownership. An “upper-tier” entity that receives a research credit from a “lower-tier” entity must file Form TC-250 (Credits Received from Upper-Tier Entities).

On Form TC-250, the upper-tier entity must list the federal Employer Identification Number (EIN) and the name of the lower-tier entity that distributed the credit. They must also provide the credit code (12) and the amount received. The total of all such credits received is then transferred to the upper-tier entity’s Schedule K, where it is combined with any credits generated by the upper-tier entity’s own research activities and then distributed to its own partners. This ensures a complete and transparent paper trail for the Tax Commission to follow during an audit.

Revenue Office Guidance: Withholding and Nonresident Owners

The Utah State Tax Commission provides extensive guidance on the obligations of pass-through entities regarding their nonresident owners. This is primarily detailed in Publication 14 (Withholding Tax Guide). Under Section 59-10-1403.2, a pass-through entity is required to withhold Utah income tax on the business income and Utah-derived non-business income attributable to its nonresident partners, members, or shareholders.

As of tax year 2025, the withholding rate in Utah is 4.5%, a reduction from the previous rate of 4.55% enacted by the 2024 legislature. This withholding acts as a “down payment” on the nonresident owner’s Utah tax liability. If a pass-through entity generates a research credit, that credit can significantly impact the withholding process. The entity may reduce the amount of tax it is required to withhold for a partner by the amount of any pass-through credits, like the R&D credit, that the partner is entitled to claim.

Pass-through Entity Withholding Procedures

Pass-through entities must manage their withholding accounts through the Taxpayer Access Point (TAP) system. Key administrative requirements include:

Withholding License: Every person or entity required to withhold Utah income tax must obtain a withholding tax license from the Commission.

Annual Reconciliation: Entities must file an annual reconciliation (Form TC-941E) by January 31 following the close of the calendar year.

Schedule N: Partnerships and S-corporations use Schedule N of their respective returns to calculate and report the amount of tax withheld on behalf of their partners.

Payment Coupons: If paying by check, the entity must use Form TC-941PC.

Failure to comply with these withholding requirements can result in significant penalties. For example, an annual reconciliation filed more than 14 days late incurs a $50 penalty, and late or missing W-2s or 1099s can lead to penalties ranging from $30 to $100 per form. Furthermore, having employees without a withholding license is classified as a class B misdemeanor in Utah.

Nonresident Professional Athletes and Composite Returns

A specific subset of pass-through entity guidance applies to nonresident professional athletes who participate in Utah-based games. Teams are often required to file composite returns or perform simplified withholding for these individuals. If a team generates a research credit (perhaps through advanced sports science or equipment development), that credit is allocated to the athletes. Resident athletes may claim a credit on their Utah return for taxes paid to other states, but they must include a summary prepared by the team showing the allocation of income and taxes across all states.

Documentation and Audit Defensibility

The Utah research activities credit does not require a formal application or pre-approval from the state. Instead, it is “self-certified” on the taxpayer’s return. This places a significant burden on the taxpayer to maintain comprehensive and contemporaneous records to support the claim in the event of an audit.

Revenue office guidance emphasizes that taxpayers must keep all related documents with their records and that the Tax Commission may request these documents at any time to verify the validity of the credit. For pass-through entities, this documentation must be maintained at the entity level, as the individual owners who claim the credit on their personal returns generally do not have access to the detailed project and expense data.

Essential Records for R&D Claims

Technical Documentation: Project descriptions, white papers, lab notebooks, and design documents that demonstrate how the research satisfies the four-part test, particularly the “process of experimentation” and “elimination of uncertainty” prongs.

Payroll Records: Detailed W-2 data and time-tracking records that show the percentage of time employees spent on qualified research activities within Utah.

Expense Ledgers: General ledger accounts specifically for research supplies and materials consumed in Utah.

Contractor Agreements: Signed contracts and invoices for third-party research services, including evidence that the research was performed in Utah and that the taxpayer retained substantial rights to the research results.

Gross Receipts Data: Records of Utah-sourced gross receipts for the current year and the four preceding years to substantiate the base amount calculation.

The statute of limitations for auditing an income tax return in Utah is generally three years from the date the return was filed or the due date of the return, whichever is later. However, because the incremental research credit can be carried forward for 14 years, the Tax Commission may examine the records from the year the credit was generated even if that year is technically “closed” for the assessment of new taxes, in order to adjust the amount of carryforward available in “open” years.

Administrative Oversight and the Revenue and Taxation Interim Committee

The Utah research tax credit is subject to periodic legislative review to ensure it is meeting its intended goals of economic development and innovation. Sections 59-7-612 and 59-10-1012 mandate that the Revenue and Taxation Interim Committee address several key questions in their study of the credit.

The committee is required to evaluate the fiscal cost of the tax credits, the purpose and effectiveness of the credits in encouraging research activities, and whether the credits provide a net benefit to the state. Based on these findings, the committee must issue a report and recommend whether the credits should be continued, modified, or repealed. Furthermore, the Tax Commission is required to report to the committee any time the federal government modifies or repeals Section 41 of the Internal Revenue Code, so the state can determine if it should maintain conformity or decouple from the federal changes.

Practical Example: Multi-Component Credit Application

To demonstrate the intersection of pass-through entity law and the research activities credit, consider the case of “AeroDynamics Utah LLC,” a specialized drone technology firm organized as a partnership. AeroDynamics has two partners: Partner A (a Utah resident with 70% ownership) and Partner B (a Nevada corporation with 30% ownership).

In the 2024 tax year, AeroDynamics conducted the following activities entirely within its Salt Lake City facility:

Total Utah Qualified Research Expenses (QREs): $2,500,000

Utah Gross Receipts for 2020–2023 (Average): $15,000,000

Fixed-Base Percentage (Startup Election made in 2021): 3.0%

Payments to Utah State University for Basic Research: $250,000

Basic Research Base Amount: $100,000

Step 1: Entity-Level Credit Calculation

1. Incremental QRE Credit (5%):

Base Amount = $15,000,000 × 0.03 = $450,000

Excess QREs = $2,500,000 – $450,000 = $2,050,000

Credit = $2,050,000 × 0.05 = $102,500

1. Basic Research Credit (5%):

Excess Payments = $250,000 – $100,000 = $150,000

Credit = $150,000 × 0.05 = $7,500

1. Volume Credit (7.5%):

Credit = $2,500,000 × 0.075 = $187,500

Total Credits Generated by AeroDynamics: $102,500 + $7,500 + $187,500 = $297,500

Step 2: Allocation and Reporting

AeroDynamics reports the $297,500 total on Form TC-65, Schedule K, Line 17, using code 12. It then issues Schedule K-1s to its partners:

Partner A (70%): Receives a credit allocation of $208,250.

Partner B (30%): Receives a credit allocation of $89,250.

Step 3: Individual and Corporate Claims

Partner A (Utah Resident):

Partner A has a Utah tax liability of $150,000. They claim the $208,250 credit on Form TC-40A.

They use $150,000 of the credit to reduce their tax to zero.

The remaining $58,250 must be categorized. The portion attributable to the 7.5% volume credit ($131,250 share) cannot be carried forward. Since the partner used $150,000 of credit, and the total incremental/basic credits were only $77,000 ($110,000 total entity incremental $\times$ 70%), they have used all of their carryforward-eligible credits and a portion of their volume credit. They have no carryforward.

Partner B (Nevada Corporation):

Partner B is a corporate taxpayer in Utah because of its interest in the partnership. It files Form TC-20.

Its share of AeroDynamics’ income results in a Utah tax of $40,000.

It uses $40,000 of its $89,250 credit to reduce its tax to zero.

Like Partner A, it must determine if the unused $49,250 can be carried forward based on whether it originated from the incremental or volume components.

Interaction with Other State Tax Provisions

The R&D tax credit does not exist in a vacuum; it interacts with other Utah incentives and federal tax changes. For instance, the Life Science Establishment Investment Credit (§ 59-10-1025) provides a similar pass-through mechanism for investments in biotechnologies and medical devices, but it has a different non-carryforward rule and requires a specific tax credit certificate from the Governor’s Office of Economic Opportunity.

Furthermore, the 2017 federal Tax Cuts and Jobs Act (TCJA) introduced changes to IRC Section 174, requiring the capitalization and amortization of R&D expenses rather than immediate deduction. While most states, including Utah, generally conform to the IRC, the interaction between Section 174 capitalization and the calculation of “qualified research expenses” for the credit remains a critical area of focus for tax professionals. Taxpayers should also be aware of the “SALT workaround” (Pass-through Entity Elective Tax) enacted in Utah in 2022, which allows PTEs to pay tax at the entity level to circumvent the federal $10,000 cap on state and local tax deductions. While this elective tax changes who pays the tax, it does not fundamentally alter the availability of the research activities credit for the owners.

Final Thoughts

The Utah research activities tax credit provides a robust and flexible incentive for innovation, specifically tailored to the needs of both growing startups and established technological leaders. By leveraging the pass-through entity structure, the state allows the financial benefits of the credit to flow directly to the investors and owners who drive research initiatives. The integration of federal Section 41 definitions with Utah-specific geographic and sourcing requirements ensures that the credit is both administratively feasible and economically targeted.

For claimants and taxpayers, success in utilizing the credit depends on a deep understanding of the three-component calculation, the strategic use of the startup election, and a commitment to rigorous documentation. The 14-year carryforward for incremental spending offers long-term stability, while the 7.5% volume credit provides immediate relief for sustained research efforts. As the Utah State Tax Commission continues to provide guidance through publications like Publication 14 and formal administrative rules, pass-through entities remain the primary vehicle for navigating the state’s innovation economy. Compliance with withholding obligations and the accurate use of forms like TC-65, TC-250, and Schedule K-1 are essential to ensuring that these valuable tax attributes are preserved and utilized to their maximum potential.