Virginia's residents can now avoid the effects of the $10,000 ceiling on state and local taxes enacted by Congress in 2017. In making the change, Virginia joined the list of states implementing a Pass-Through Entity Tax (PTET) regime. PTET regimes generally allow pass-through entities (PTEs) such as partnerships and S corporations to pay tax on their income subject to tax in the state rather than having the income taxed at the partner level. If the tax payment qualifies as a business deduction, the PTE is generally allowed to deduct the total amount, and the deduction flows through to the PTE owners. The PTET regimes intended to provide individual PTE owners a federal deduction for state tax that is not subject to the $10,000 limitation on state and local tax imposed by the Tax Cuts and Jobs Act of 2017 at the individual level. Virginia’s PTET allows a qualifying PTE to make an annual election for tax years 2021 through 2025 to pay a state income tax at 5.75% at the entity level.
Qualifying PTEs include limited and general partnerships, limited liability partnerships, limited liability companies, electing large partnerships, S corporations, and business trusts. The qualifying PTE must be 100% owned by natural persons or, in the case of S corporations, 100% owned by natural persons or other persons eligible to be shareholders in an S corporation. Virginia’s PTET provides a corresponding refundable income tax credit to the PTE owners for any amount of income tax paid by the PTE. The PTE owner applies for the refundable income tax credit against Virginia tax that would otherwise be due on the PTE flow-through income.
According to the Virginia Department of Taxation, the effect of elective PTE income tax and corresponding refundable credit is to allow the qualifying PTE to shift the income tax burden from the PTE owners to the PTE itself. The Virginia Department of Taxation released a bulletin stating that due to the timing of the legislation and because the filing season for tax year 2021 is already underway, the implementation of the PTET will be delayed until at least October 15, 2023, but the transition rules are complicated, and taxes paid in 2022-2025 may be eligible for credit in future years. Contact your tax professional at Saggar & Rosenberg to see if you can take advantage of this new opportunity.
