Virginia’s New Elective PTE Tax and SALT Cap Workaround

Elective PTE Income Taxes Payable to Virginia

Beginning July 1, 2022, Virginia’s new law establishing a workaround for the federal income tax limitation on deductions for state and local taxes (SALT) became effective. Owners of pass-through entities (PTEs), such as partnerships, limited liability companies, and S Corporations, may qualify for significant federal income tax savings.

Virginia’s new law allows certain qualifying PTEs to make an annual election to pay an income tax at a rate of 5.75% at the entity level. The election is available for tax years 2021 (retroactive) through 2025. The legislation provides a corresponding refundable income tax credit for any amount of tax paid by the qualifying PTE to the PTE owners to offset their Virginia income tax liabilities. The amount of the credit is equal to such PTE owner’s pro rata share of the tax paid by the PTE. For Virginia income taxes, the electing qualifying PTE and the PTE’s owners are required to add-back their respective federal deductions for SALT attributable to the Virginia elective PTE tax.  The effect of such elective program is to allow the qualifying PTE to shift the income tax burden from the PTE owners to the PTE itself.

PTEs are not subject to the $10,000 limitation (assuming married and filing jointly) on SALT deductions that individual taxpayers face. The legislation legalizes in Virginia a form of SALT cap workaround enacted in other states.  The elective PTE tax allows the qualifying PTE to take the SALT deduction without the limitation, which lowers the net taxable income passed through to the PTE owners and lowers the PTE owners’ federal income taxes.

According to the new law, a qualifying PTE means a pass-through entity that is 100% owned by natural persons or, in the case of an S Corporation, 100% owned by natural persons or other persons eligible to be shareholders in an S Corporation.  We are awaiting further guidance from the Virginia Department of Taxation on open questions regarding the qualification of PTEs with other ownership structures.  For Virginia income tax law, PTEs generally include general partnerships, limited partnerships, limited liability partnerships, limited liability companies (taxed as partnerships), S Corporations, and certain business trusts.

Because the new law passed this spring during tax season, the Virginia Department of Taxation needed time to implement the elective PTE tax program. The Virginia Department of Taxation issued guidance on April 15, 2022 stating that it will publish guidance before October 15, 2023, on (a) how qualifying PTEs can make the election and pay the tax and (b) how qualifying PTE owners can claim the corresponding refundable income tax credits (i) retroactively for tax year 2021 and (ii) prospectively for tax years 2022 through 2025.  For tax year 2021 returns, the Virginia Department of Taxation instructed PTEs to timely file their income tax returns and not pay the elective PTE tax.  The guidance likewise directs individuals who are owners of qualifying PTE to timely file their income tax returns and not claim a credit for the elective PTE tax.

Planning Tips:

  • Generally, any qualifying PTE in an asset or membership interest sale through 2025 would benefit its Virginia-resident owners by making the election. The PTE would need sufficient funds in reserve post-closing to pay the Virginia tax due.
  • Tax distributions may need to be recharacterized or recalculated depending on the terms of the operating agreement or shareholder agreement.
  • PTE owners should consult their operating agreement or shareholder agreement to determine the authority for making the election.
  • Qualifying PTEs planning to make use of the election need sufficient cash on hand to pay the tax due.

Key Takeaway: Although Virginia’s SALT cap workaround is effective, the Virginia Department of Taxation instructs PTE owners to wait for further guidance before their PTE pays the tax and they attempt to claim the corresponding credit. According to the Virginia Department of Taxation, for the 2021 tax year, PTE and PTE owner tax returns should be timely filed.

Expansion of Credits for PTE Income Taxes Payable to Other States

The new law also expands the credits for taxes paid to other states by allowing PTE owners to claim a credit on their individual income tax return for taxes paid by their PTE under another state’s PTE income tax structure that is substantially similar to Virginia’s elective PTE tax program (see above) for tax years 2021 through 2025.  These credits are allocated in proportion to ownership of the PTE.  This expansion does not apply to any other entity-level taxes such as any franchise, license, excise, unincorporated business, and occupation taxes.

The implementation of the expansion is not delayed.  PTE owners may claim the credits on their 2021 income tax returns currently.  If PTE owners previously filed their 2021 income tax returns, then after determination of whether they qualify, amended returns can be filed to make adjustments.

Key Takeaway: If you are a PTE owner who files an individual income tax return in Virginia and your PTE pays income taxes to another state, then you should consult your tax advisors regarding these expanded Virginia income tax credits.

We will continue to monitor the Virginia Department of Taxation for further developments regarding the guidance on and implementation of the Virginia elective PTE tax program.

If you have any questions on how these tax changes may affect you or your business or regarding any of your other legal needs, please feel free to reach out your Sands Anderson attorney contact and we will address your issue.

For any questions you have on PTE taxes or any other tax-related issue, contact David Gundlach at dgundlach@sandsanderson.com or any member of Sands Anderson’s Tax Team.

Disclaimer: The information contained herein is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax, legal, and financial advisers. This summary is not intended, and should not be construed, as accounting, business, financial, investment, legal, tax, or other professional advice, services, or opinion provided by Sands Anderson PC. Sands Anderson PC shall not be responsible for any loss incurred by any person who relies on this summary.