Virginia’s Department of Taxation has issued long-awaited guidance on pass-through entity tax returns. Here’s what the guidance means for owners of pass-through entities.
Background
In 2022, the Virginia General Assembly passed bills that permitted a qualifying pass-through entity (PTE) to make an annual election to pay income tax at the entity level, with a corresponding refundable credit provided to eligible PTE owners for their portion of the Virginia pass-through entity tax. The election is available to qualifying PTEs for tax years 2021 through 2025.
You can read more about the legislation in our blog post, New Virginia Law Affects Taxation of Pass-Through Entities.
Since the bills were passed in 2022 with retroactive availability to tax year 2021, the Virginia Department of Taxation (VDOT) issued Virginia Tax Bulletin No. 22-6 notifying taxpayers not to file or pay under the new elective methodology for tax year 2021 at that time, pending further guidance to be issued by the agency.
On February 19, 2024, Virginia issued Public Document Ruling 24-12, Guidelines for the Retroactive Taxable Year 2021 Pass-through Entity Tax (PTET). The guidelines clarify how a pass-through entity should file a retroactive election to be taxed at the PTE level for tax year 2021.
How & When PTEs Should File the Retroactive Election
Under the new guidelines, a PTE that was “qualified” to make a PTET election in tax year 2021 may make the election and file the associated tax return retroactively. A qualifying PTE is one that had at least one eligible owner during tax year 2021.
A qualifying PTE may file the retroactive election by filing the 2021 Virginia Form 502 PTET return, including all owner credit allocation information and making all tax payments prior to, or at the time of, submitting the return. The return and all required payments must be electronically submitted by September 16, 2024, using Virginia Business Online Services via the VDOT website. No returns or payments will be accepted after that date, nor are there extensions of time to file or late filing options.
A qualifying PTE making the 2021 election must decide how to obtain consent from its owners to make the election because an eligible owner cannot opt out of the election once made by the PTE. Since these elections can materially impact tax, electing PTEs should obtain and document consent to the elections before finalizing the return. The electing PTE must also notify all owners of the election, whether the owner is eligible or not, and provide all owners a Schedule VK-1 showing their distributive income, and related deductions and credits.
Generally, nonresident owners of electing PTEs are allocated PTET credits based on their Virginia apportioned pro-rata share of PTE liability while resident owners are allocated PTET credits based on 100% share of electing PTE income after state modifications.
Electing PTEs that previously filed a tax year 2021 Virginia Form 502 must claim all nonresident withholding payments on behalf of those eligible owners as a reduction from their share on the PTE’s tax liability due on the return. This will reduce the amount of PTET liability and available PTET credits paid on their behalf as that portion of the credit has already been received and claimed on their previously filed 2021 Virginia individual income tax returns.
Due to the reductions associated with nonresident withholding previously taxed, and credits on behalf of nonresident eligible owners, the 2021 election will primarily benefit Virginia resident eligible owners of PTEs with limited relief to such nonresident eligible owners.
Eligible owners of an electing PTE will receive a credit for the PTET paid on their distributable income. The tax year 2021 PTET credit can only be claimed on the eligible owners’ 2023 tax year Virginia individual income tax returns. While the 2021 PTET credit is reported on each owner’s 2023 Virginia income tax return, it is based on the 2021 taxes of each owner and the electing PTE.
Eligible owners claiming a tax year 2021 PTET credit on their 2023 Virginia individual or fiduciary income tax return must make an additional modification for their share of any deduction for state and local income taxes paid or incurred by the PTE during the tax year.
It is also worth noting that for federal income tax purposes, any Virginia 2021 PTET payment should be deductible in the tax year it is paid. As such, for calendar year taxpayers this deduction would be reflected on their 2024 income tax return.
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