Virginia Passes Tax Law for Owners of Pass-Through Entities

Renner Business News; December 13, 2022 — Joan M. Renner, CPA, CGMA

The 2022 Virginia General Assembly has enacted a new law for 2021-2025, which allows qualifying pass-through entities (PTEs) to elect to shift the income tax burden from the individual PTE owners (who may not be able to deduct the tax) to the PTE itself (who now can deduct the tax).

Individuals Face Tax Deduction Cap

As you know, an individual can only deduct up to $10,000 of taxes on his or her individual return as itemized deductions. Federal tax law limits the individual itemized deduction to $10,000 for state and local taxes (SALT) such as real estate tax, property tax and state income tax. This limit leaves many individual taxpayers paying taxes they can not deduct.

Virginia Now Allows Entities to Pay Tax

Virginia is one of 29 states that has enacted a workaround for the federal SALT deduction limitation for income derived from a pass-through entity (PTE).

Pass-through entities include partnerships, S-Corporations, LLCs, LLPs, limited partnerships, professional LLCs and business trusts that are recognized as a separate entity for tax purposes.

Before the enactment of this provision, PTE owners paid tax on PTE income on their individual returns, and the state income tax they paid was subject to the $10,000 cap on state and local tax deductions on their federal return—a deduction that was often limited.

PTEs can now elect to pay and deduct tax at the entity level and give PTE owners credit for the payment. The tax rate is 5.75%, the same as the Virginia individual income tax rate.

How it Works

Under the new provision, PTEs elect to pay tax on the entity’s income at the entity level, and give the individual owners credit for having paid it.

Then, when the PTE income is included in taxable income on the individual state return, the individual owners take a refundable credit for the tax already paid. The PTE deducts the state taxes rather than the individual owners.

Instead of having an itemized deduction that’s limited, the owners get a reduction in their federal K-1 income for the tax paid by the PTE. The result is a smaller tax bill for individual owners.

Who Can Elect

PTEs with owners that are other PTEs are not eligible to elect to pay this PTE tax. To be eligible to elect the PTE tax, PTEs must be 100% owned by individuals or, for S Corps, by individuals or certain estates and trusts that are eligible to be S Corp owners.

How to Elect

PTEs that want to elect to pay tax at the entity level must make an election before the due date of the return, including extensions. PTEs electing the PTE tax need to file Virginia Form 502PTET rather than Form 502. PTEs electing the PTE tax must file electronically and make all payments electronically.

Qualifying PTEs can elect for 2022 in a number of ways including by:

Making 2022 PTE tax payments with Form 502V,
Making an extension payment for PTE tax for 2022, or
Filing Form 502PTET on or before the extended due date of the 2022 return.

Filing Form 502 instead of Form 502PTET revokes the election. Once a PTE files Form 502PTET, the election can not be revoked for that year.

Pay PTE Tax Before Year-End to Get the Federal Deduction

If a PTE waits to pay its 2022 PTE tax until it files Form 502PTET for the year, the PTE doesn’t get the federal tax deduction until 2023 (the year paid). State tax payments made by the PTE are deductible on the PTE’s federal return in the year they are paid. PTE owners still get credit for 2022 payments made after year-end, but the PTE will not get a deduction in 2022 for PTE tax payments made in 2023.

More Info

The PTE reports each individual owner’s credit for tax payments made on the owner’s VK-1.
Electing the PTE tax precludes the filing of a composite return.
Individual owners may not opt out of the entity-level tax.
The Virginia General Assembly provided for the PTE tax to begin in 2021. However, the Virginia Department of Taxation is not implementing the PTE tax for 2021 until October 15, 2023.
https://www.tax.virginia.gov/elective-pass-through-entity-tax-guidelines
The State of Maryland is one of the 29 states that have enacted similar legislation. The rules are different in each state, so contact your tax advisor for more information.

This is a general overview of Virginia’s PTE tax and how it may save tax for PTE owners. There is more to know about Virginia’s PTE Tax.