Virginia recently joined the list of states that have established a new pass-through entity tax (PTET) for business entities doing business in the state. House Bill 1121, signed into law by Gov. Glenn Youngkin on April 11, also modifies existing legislation to expand the credit available to Virginia resident individuals for taxes paid to other states. 

New elective PTE tax

The enacted House Bill created Virginia Code Section 58.1-390.3, which allows for a new PTET election for pass-through entities (PTEs) doing business in Virginia to choose to pay state income tax due at the entity level on behalf of its individual owners. For tax years beginning on or after Jan. 1, 2021, but before Jan. 1, 2026, qualifying PTEs may elect to pay tax at the entity level for each tax year at a rate of 5.75%. Qualifying PTEs include any PTEs owned 100% by individuals, or S corporations owned 100% by individuals, or other persons eligible to own an S corporation. This elective PTET is created in response to the $10,000 federal limitation on state and local taxes allowed to be deducted on federal individual income tax returns.

The due date for the election for tax years beginning on or after Jan. 1, 2021, but before Jan. 1, 2022, is yet to be determined. The Virginia Department of Taxation’s recently issued Tax Bulletin 22-6 declares that they will issue guidance on how eligible PTEs will be able to make a retroactive PTET election for their 2021 tax year by Oct. 15, 2023. 

For tax years beginning on or after Jan. 1, 2022, but before Jan. 1, 2026, the PTET election must be made by a qualifying pass-through entity on its timely filed return, including any extensions.

New individual PTE/owner tax credits

Individuals who are owners of qualifying PTEs that make the PTET election are eligible to receive a refundable credit for their pro-rata share of PTET tax paid on their behalf at the entity level. 

Additionally, for taxable years beginning on or after Jan. 1, 2021, but before Jan. 1, 2026, a credit is available for any income tax paid to another state that is substantially similar to the newly enacted Virginia PTET (i.e., Maryland, New York, Connecticut PTETs). This credit could be generated from payments by either S corporations or partnerships. Prior guidance from the Virginia Department of Taxation had only allowed such credit for taxes paid by S corporations, but not partnerships. 

The credit for taxes paid to other states does not extend to taxes that are solely intended to be a tax at the PTE level and not intended as an income tax paid on behalf of its individual owners. Examples of such state PTE taxes that are ineligible for the credit include a franchise tax, license tax, excise tax, unincorporated business tax, occupation tax or other similar taxes. Ineligible taxes not availed the credit falling under these examples would include the Texas Franchise Tax, Tennessee Franchise & Excise Tax, NYC and D.C. unincorporated business taxes, Philadelphia Business Income & Receipts Tax, Washington Business & Occupation Excise Tax, and any state tax based on apportioned net worth.

Takeaways

Election procedures for tax years beginning on or after Jan. 1, 2021, but before Jan. 1, 2022 (2021 Tax Year), will not be issued by the Department until well after the extended due date of the Form 502 pass-through entity income tax return. In light of this, PTEs doing business in Virginia should file their return for their 2021 Tax Year in accordance with existing due dates.

An eligible PTE owner’s federal and state income tax positions should be analyzed prior to making such PTET election, as the state generally renders tax return filing elections as irrevocable.

Contact

John Iannotti, Partner, State & Local Tax

678.640.3293

Marissa McClain, State & Local Tax

301.280.3519