Overview of Virginia’s Pending Tax Changes for Pass Through Entities

Virginia Aims to Alleviate Additional Federal Tax Burdens for Business Owners

In 2017, Congress passed legislation that significantly limited an individual taxpayer’s state income tax deductions (SALT Cap). This move impacted pass-through business owners because the business’ state taxes are paid by the owners. Some states have reacted to this by creating entity level state taxes that may be paid by the company (SALT Workarounds).

Proposed Legislation May Add to Virginia State Tax Complexities

During the current legislative session in Virginia, the House and Senate approved pro-business legislation to alleviate the additional tax burden caused by the federal law that limits the state tax deduction for business owners. The legislation is pending the Governor’s signature but may create complexities for Virginia tax return filings in 2021 and beyond.

The legislation, if passed, will provide for a Virginia Pass-Through Entity Tax (PTE Tax) as well as a Credit for Other States Taxes (OSC) paid to other states.  Each is docketed to be EFFECTIVE for CALENDAR YEAR 2021. SALT Cap Workarounds have been adopted by a number of states to “work around” the federal limitation of $10,000 for individual’s itemized deductions for state and local taxes paid for taxable years January 1, 2018, and before January 1, 2026 (part of the federal Tax Cuts and Jobs Act (TCJA)). The workaround effectively allows owners of pass-through entities (PTE) to avoid the $10,000 limitation on their federal returns by transferring the state tax burden from the individual owners to the PTEs.

The legislation, if passed, will result in significant federal tax savings for pass-through business owners that are individuals.

Originally, it was understood that the PTE Tax would be available for 2022 and forward; however, language was recently revised to include the 2021 tax year. Based on discussions with the Virginia Department of Taxation, they are studying the legislation and are working on ways to administer it for the 2021 tax year, once approved. There is no current timeline for when this would be available.

More PTE Tax and OSC Details

Virginia SALT Cap Workaround (PTE Tax)

The proposed legislation provides that a qualifying pass-through entity may elect for Taxable Year 2021 through Taxable Year 2025 to pay Virginia tax at the rate of 5.75% at the entity level. This will be an annual election. A qualifying PTE is one whose owners are all natural persons or, in the case of PTEs that are S corporations, certain estates and trusts that are permitted to own S corporation shares. A corresponding refundable individual or fiduciary income tax credit is allowed for tax years 2021 through 2025 for any amount of income tax paid by the PTE having Virginia taxable income if the PTE makes the election and pays the tax at the entity level.

What is the timeline for making the election?

The Department of Taxation has not indicated a timeline for providing substantiated guidance on how to make this election, how to report on tax returns, or how to remit the PTE Tax payment. We expect such guidance to be forthcoming once the legislation is signed into law.

The Virginia Department of Taxation has recommended that taxpayers file their normal returns for tax year 2021 (by the regular or extended due date).  The taxpayer would then presumably have until October 2023 (12 months after the extended due date) to file amended returns to make the election (for tax year 2021). The provision would provide that no interest will be refunded due to overpayments or charged in the case of underpayments (assuming the original returns were timely filed).  This will allow the Virginia Department of Taxation time to develop guidelines and taxpayers time to determine whether to make the election to pay at the entity level. We have no indications of how or when further guidance will be available at this time.

Credit for Taxes Paid to Other States (OSC)

For Virginia pass-through entities that have operations in other states, current Virginia law restricts the individual owner from claiming a Virginia income tax credit for certain taxes paid by the entity in other states (including workaround situations). Virginia now has proposed legislation which would allow taxpayers to claim an OSC on their individual income tax returns for PTE taxes paid to other states by all pass-through entities for Taxable Years 2021 through 2025. Since the legislation has not yet been signed by the Governor and will not be in place until July 1, 2022, (even though applicable to tax year 2021), taxpayers with multi-state pass-through operations that may be considering PTE tax elections for other states, should consider extending 2021 Virginia tax returns until the law is finalized and/or further guidance is provided by the Virginia Department of Taxation.

The Keiter team will continue to monitor this and other tax legislation and provide timely updates so you can plan proactively. Contact your Opportunity Advisor if you have any questions or Email | Call: 804.747.0000

Sources

• Virginia Legislative Information System
• 2022 Fiscal Impact Statement, Virginia Department of Taxation