Virginia Legislation Expands Eligibility for Pass-Through Entity Tax Election
April 27, 2023
At a glance
- The main takeaway: Virginia enacted legislation to expand the types of pass-through entities that can make a pass-through entity tax election, and other states are doing so as well.
- Assess the impact: Although there are certain compliance issues that still need to be addressed, these changes are going to allow additional pass-through entity owners to obtain federal income tax benefits.
- Take the next step: Aprio’s State and Local Tax (SALT) team can navigate your business through the benefits and costs of making a PTET election, including the impact on each PTE owner.
Schedule a free consultation today to learn more!
The full story:
One year after enacting an elective pass-through entity tax (PTET), Virginia passed legislation (HB 1456) revising its PTET to make it available to more businesses. However, the timing of the legislation and the fact that changes made by the bill impact the 2022 tax year may result in newly eligible pass-through entities (PTE) being assessed late payment penalties. Still, for many taxpayers, those penalties may be outweighed by the federal income tax benefit from the entity-level tax deduction created by the PTET, which then flows through to PTE owners to circumvent the federal $10,000 state tax deduction limitation imposed on individuals for federal income tax purposes.
A closer look at the new law
Last year, Virginia implemented its elective PTET by enacting Senate Bill 692.1 The PTET election under the original legislation was only available to PTEs that were 100% owned by natural persons (i.e., individuals) or by entities that were 100% owned by natural persons and disregarded for federal income tax purposes (e.g., a single-member limited liability company or grantor trust). Thus, individuals owning an interest in a PTE owned in part by a corporation or another PTE could not benefit from the state income tax deduction limitation workaround created by the PTET.
The recently enacted HB 1456, which become law by the Governor’s inaction on March 27, 2023, cures the arguably inequitable limitation of the election created under last year’s legislation. Under the amended Virginia PTET law, PTEs with owners that are not “natural persons” are now eligible to elect to be subject to the PTET. However, in calculating the PTET, only the pro rata or distributive share of income attributable to “eligible owners” is subject to the PTET. An “eligible owner” is defined as a direct owner of a PTE who is a natural person or an estate or trust. Thus, the distributive share of income attributable to non-eligible owners, such as other PTEs and corporations, is not included in the PTET tax base. Finally, the expanded eligibility for the PTET election was made retroactively effective for years 2021 and 2022. However, Virginia is yet to issue guidance on how PTEs can retroactively make a PTET election for 2021.
Understanding the immediate impact of the law
Given that the legislation was enacted so close to the 2022 tax year return filing deadlines, many may have expected the Department of Taxation (Department) to administratively extend the PTET filing deadline. However, the Department issued a bulletin shortly after the legislation became law indicating that a PTE wishing to make the PTET election for the 2022 taxable year should file their return and pay the PTET by the original filing deadline. While some PTEs may not have been able to meet this deadline, Virginia’s PTET election rules do not render a late filer ineligible to make the PTET election. Instead, a PTE has until the extended due date to make the PTET election by filing the PTET return and paying the tax. However, those taxpayers that did make the required extension payment by April 17, 2023, will be assessed penalties and interest. Nonetheless, the penalties associated with the late PTET payment may be outweighed by the federal income tax benefits associated with a PTET election.
The issue that has gone unaddressed so far by the Department is how PTEs are required to report the distributive share of income of non-eligible owners. The bulletin issued by the Department reflects that the Department will not be revising its forms. Instead, the bulletin simply states that PTEs “should ensure that only amounts attributable to eligible owners are included in the computation” of the PTET but provides no guidance on how a PTE should report the remainder of its income (e.g., distributive share of income of C corporation owner). One option would be for the PTE to file a second return using the general PTE return form. The Department has indicated that it will be revising its guidelines for PTET to provide more clarity around these types of filing issues related to Virginia’s PTET.
The bottom line
Although there are certain compliance issues that still need to be clarified as it relates to the amendments made to Virginia’s PTET, expanding the election to PTEs that are not 100% owned by natural persons alleviates the inequities that existed under the original rules. The notion that an individual should be treated differently in connection with a state’s PTET based on whether they invest in a PTE owned only by individuals as compared to investing in a PTE that might have one or more owners that are not individuals makes little sense. This is especially the case when individuals may have no control over who becomes an owner in a PTE in which they hold an interest.
This is an issue for others states that initially enacted a PTET in a similar fashion to Virginia are currently addressing. In particular, Georgia passed HB 412 that will similarly expand its PTET election to partnerships regardless of the types of owners.2 Similar legislation was also enacted in North Carolina, with SB 174 permitting partnerships that are owned by other partnerships or S corporations to be subject to North Carolina’s PTET.3
Aprio’s SALT team continues to assist businesses in addressing the benefits and costs of making a PTET election, including providing the PTE with estimates of the impact to each of the PTE owners. We constantly monitoring these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
1 You can read our summary of that legislation by clicking here.
2 At the time this article was published, the legislation was waiting on the Governor’s signature. Unlike Virginia’s legislation, the change would be prospective, beginning with the 2023 tax year.
3 NC still would prohibit a PTE with an owner that is a C-corporation from making a PTET election. Similar to Virginia’s legislation, this amendment is effective for tax years beginning on or after January 1, 2022.
About the Author
Michael assists clients with a broad range of state and local tax issues. His expertise extends to many areas of multistate taxation, including income, franchise, sales and use, and property taxes. Michael’s experience also includes representing clients at all stages of tax controversy—from audit through appellate litigation as well as advising clients on restructurings and state tax refund and planning opportunities.