Virginia Dept of Tax Issues Clarifying Guidance for Recent Changes to Pass-Through Entity Tax

The General Assembly enacted legislation (H.B. 1456 and S.B. 1476) during its 2023 Regular Session that removed some of the barriers for qualifying for Virginia’s Pass-Through Entity Tax (PTET) election and altered how PTET is calculated, which we previously covered here. As this legislation will affect filings for tax year 2022, the Virginia Department of Taxation issued Tax Bulletin 23-3 on March 29, 2023 providing guidance on how these changes will be implemented.

Replacement of the Qualifying PTE Requirement with an Eligible Owner Requirement

The legislation repeals the “qualifying pass-through entity” requirement and replaces it with a new “eligible owner” requirement. Prior to the legislation, the qualifying pass-through entity had to be owned 100% by natural persons or, in the case of an S corporation, persons eligible to be shareholders of an S corporation.  As a result, pass-through entities (PTEs) owned in part or in full by corporations, other PTEs, estates, trusts, and other PTEs were prohibited from making the election.

Under the new eligible owner requirement, only a direct owner of a PTE who is a natural person subject to Virginia individual income tax or an estate or trust subject to Virginia’s fiduciary income tax may claim a refundable PTET credit. As a result of these changes, all PTEs can make the PTET election if it has one or more eligible owners. However, only the PTE’s eligible owners may claim the refundable PTET credits. 

Under the new rules, corporations still will not receive a direct benefit from the PTET election. Also, an upper-tier PTE still will not be an eligible owner of any lower-tier PTE. However, the upper-tier PTE may benefit from making an election if it has members who are eligible owners.

Changes to the PTET Computation

The legislation also provides that only the pro rata or distributive share of income, gain, loss, or deduction attributable to eligible owners is subject to the PTET. Amounts attributable to non-eligible owners, such as corporations and other PTEs, are not subject to the PTET. Tax Bulletin 23-3 provides that, when completing Form 502PTET, PTEs should ensure that only amounts attributable to eligible owners are included in the computation on Page 2, Section 1.

Effective Dates for the PTET Changes

The legislation is effective July 1, 2023 but applies to tax years beginning on or after January 1, 2021. This has caused questions by accountants on how to make 2022 PTE filings. Tax Bulletin 23-3 answers these questions:

• All PTEs making a PTET election and filing by the original due date (April 17, 2023) should prepare their returns and pay the amount due based on the changes to the PTET computation made by the new legislation. 
• PTEs filing by the automatic extended due date (October 16, 2023) must pay 90% of the tax owed by the original due date to avoid the extension penalties. Tax Bulletin 23-3 provides that the extension payment should be computed in accordance with the changes to the PTET computation made by the new legislation. All taxes due on the return must be paid on or before the date the return is filed during the extension. Based on the Tax Bulletin, it appears that payments made after the return is filed but on or before October 16, 2023 will be subject to the penalty.
• No action is required for PTEs that already have filed for 2022. Tax Bulletin 23-3 provides that the legislation does not change the computation of the PTET for them.
• Regarding elections for tax year 2021, Tax Bulletin 23-3 provides that PTEs should continue to follow the guidance provided in Tax Bulletin 22-6. 

Conclusion

The new legislation provides flexibility for PTEs wishing to make a PTET election. Williams Mullen will continue to monitor developments regarding the PTET. To view a summary of all recent changes, please click here to view a table that summarizes the tax legislation enacted by the General Assembly during its 2023 Regular Session and approved by Gov. Youngkin that will become law on or before July 1, 2023.