Virginia Department of Taxation Releases Initial Guidance on New Pass-Through Entity Election, Including Important Details for Filing 2021 Returns

During the 2022 General Assembly Session, legislation was enacted that allows a qualifying pass-through entity (PTE) to make an annual election for Taxable Years 2021 through 2025 to pay income tax at a rate of 5.75% at the entity level. The legislation was intended as a workaround to the $10,000 federal limitation for individuals to deduct state and local taxes.

A qualifying PTE is one that is 100% owned by natural persons or, in the case of a Subchapter S corporation, 100% owned by natural persons or other persons eligible to be shareholders in an S corporation. On its face, the legislation makes no provision for ownership by other PTEs, including tiered LLC structures, or ownership by grantor trusts. Williams Mullen has previously reported on this legislation.

On April 15, 2022, the Virginia Department of Taxation (the “Department”) published Tax Bulletin 22-6 providing initial guidance on the annual PTE election. The bulletin provides the following guidance to PTEs and individuals regarding their 2021 returns:

Preliminary Instructions for Taxable Year 2021 Returns

Due to the timing of the legislation and because the filing season for tax year 2021 is already under way, the Department will delay implementation of the elective PTE tax until at least October 15, 2023. Therefore, qualifying PTEs will not be able to make an election, nor will they be able to pay the entity-level tax, permitted by this legislation on tax year 2021 returns by the original or extended due date. Similarly, owners of a qualifying PTE will not initially be allowed to claim the refundable income tax credit allowed by this legislation on their Taxable Year 2021 return by the original or extended due date.

Before October 15, 2023, the Department will publish guidelines regarding how to make the election retroactively for Taxable Year 2021. A qualifying PTE will then be permitted to make an election and pay the entity-level tax for Taxable Year 2021 according to the guidelines to be published by the Department. In addition, owners of a qualifying PTE will be allowed to claim the refundable income tax credit for Taxable Year 2021 according to such guidelines. The guidelines will also address the implementation of this legislation for Taxable Years 2022 through 2025.

Modification of Virginia’s Existing Credit for Taxes Paid Other States

This provision of the legislation overrules Public Document 21-156 (December 29, 2021), which generally denied a credit for a tax paid to Maryland under that state’s elective pass-through entity tax. This provision only applies to taxes paid by a pass-through entity under the law of another state that is substantially similar to Va. Code § 58.1-390. Therefore, it does not apply to any other entity-level taxes, such as any franchise, privilege, business, license, or occupation taxes described in Va. Code § 58.1-332.2.

Unlike the new elective PTE tax, Tax Bulletin 22-6 provides that the implementation of this provision is not delayed. Therefore, taxpayers may claim a credit on their Taxable Year 2021 individual income tax returns for taxes paid by the PTE under another state’s substantially similar PTE tax structure in proportion to their ownership in such PTE.

Williams Mullen will continue to monitor developments relating to the Virginia PTE election.