New Virginia Law Affects Taxation of Pass-Through Entities

Virginia’s Department of Taxation issued guidance on the
PTE legislation in early 2024. Read more here.

A new Virginia law allows the owners of a pass-through entity (PTE) to shift their income tax burden generated from the PTE away from them personally and instead to the PTE itself.

Virginia PTEs include S corporations, general partnerships, limited partnerships, limited liability partnerships, limited liability companies, electing large partnerships and business trusts.

Let's dive into the advantages of the new law and its implications for the 2021 and 2022 tax years.

Background

The Virginia General Assembly recently passed legislation that allows PTEs to elect to pay Virginia income tax at the entity level instead of requiring the income to pass through to the owner's return. The entity pays a tax rate of 5.75%.

This law goes into effect on July 1, 2022 and is retroactive to the 2021 tax year. Entity owners will receive a tax credit on their Virginia returns equal to the tax paid by the entity.

Advantages of the Elective Pass-Through Entity Tax

By electing to have a PTE taxed directly by the state, the tax paid is deductible against the federal income reported by the entity. Virginia will make you add this deduction back to income. Through deducting the tax against the entity’s federal income, you bypass the limitation on state and local tax deduction on Schedule A.

For example, if a PTE had Virginia taxable income of $500,000, it could elect to pay $28,750 in Virginia tax. This $28,750 would then be deductible against federal income. If the owners of the PTE are in the 32% tax bracket, the federal savings from electing to pay the tax at the entity level is $9,200 (32% x $28,700). If you decided not to pay at the entity level, the max tax benefit would be $3,200 ($10,000 x 32%). This is at least $7,000 in tax savings.

Owners of multi-state partnerships also have a reason to celebrate the new law, as it allows owners to receive a credit for PTE tax paid to other states. Previously, the Virginia Department of Taxation’s view of the existing law did not allow a tax credit for PTE taxes paid by a partnership since the partnership was liable for the tax, not the partners. But now, the new law expressly permits a tax credit for PTE tax paid to a different state.

What Does This New Law Mean for the 2021 Tax Year?

On April 15, the Virginia Department of Taxation published Tax Bulletin 22-6, which provides initial guidance on the new law:

• For 2021 PTE tax returns, the department does not currently have the mechanisms needed to review and collect the tax and won’t until October 2023.
• PTEs should file their 2021 tax returns normally and look to amend the 2021 returns in 2023. In other words, file your 2021 tax returns as if the law was not passed.
• Extension/late payment penalties will be assessed as if the law does not exist. However, since guidance was not released until PTE payments were due, we believe the department will eventually be required to decrease the penalties. So, we recommend requesting abatement of any extension/late payment penalties that are assessed.

What Does This New Law Mean for the 2022 Tax Year?

For tax year 2022, no guidance has been released at this time. The Department of Taxation does not have any processes in place to collect PTE tax for 2022. Therefore, do not attempt to make any estimated tax payments for your PTE at this time.

As for putting in place the election to have your PTE taxed directly, time will tell. Presumably, the department will set up the necessary mechanism to collect PTE tax payments and make the election for your PTE to be taxed directly before the end of the year. When we have further guidance, we will pass it along.

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This article was originally published in May 2022 and was updated in May 2024.