On January 17, the Virginia Department of Taxation (DOT) issued final guidelines for the commonwealth’s pass-through entity tax (PTET) for tax years 2022 through 2025, and on March 4, it issued guidelines for making a retroactive PTET election for tax year 2021.
Final PTET Guidelines
On October 31, 2022, the DOT issued draft PTET guidelines.
The final guidelines clarify several aspects of the draft guidance, including the definition of an eligible owner and the addback of the Virginia PTET on the individual return. They also introduce a “Special Option” for some S corporations. The guidelines provide details on filing the annual PTET return, distributing the PTET credit, making estimated payments, filing returns by eligible owners, and ordering credits. The guidelines contain information on the credit for taxes paid to other states with substantially similar PTET laws.
Definition of an Eligible Owner
The guidelines adopt the definition of an eligible owner adopted in legislation passed in March 2023. S.B. 1476 (identical to H.B. 1456) removed the requirement that a PTE must be 100% owned by natural persons or persons eligible to be shareholders of an S corporation to make the PTET election.
Addback of Virginia PTET
For individual owners, Virginia requires an addback of the PTE taxes to compute Virginia taxable income. The final guidelines offer helpful examples to explain the rules, including notably, that the addback is limited to the owners’ shares of the expense deducted by the PTE in the same tax year, regardless of whether it differs from the year in which the PTET credit is distributed to the PTE owners.
Special Option for S Corporations with Resident and Nonresident Owners
S corporations with both resident and nonresident eligible owners may choose to compute their Virginia taxable income as if all owners are nonresidents. That election allows Virginia residents who are eligible owners to be taxed on the S corporation’s apportioned income, rather than on 100% of the corporation’s income.
Estimated Payments
Starting in tax year 2023, estimated payments are mandatory if the PTET for the tax year is expected to exceed $1,000. For calendar-year filers, four quarterly installments are required: 25% by April 15, 25% by June 15, 25% by September 15, and 25% by December 15. Non-calendar-year filers must pay 25 percent of the amount due by the 15th day of the fourth, sixth, ninth, and twelfth months following the start of their fiscal years. Underpayment interest and penalties will apply to taxpayers who make the PTET election and did not make estimated payments in 2023.
Because of problems arising from the PTET election’s implementation and because the draft guidelines had yet to be finalized, the Virginia Society of CPAs sought guidance on penalties for not making estimated payments in November 2023. In January 2024, the DOT replied, stating that while a blanket penalty abatement will not be issued for tax year 2023, requests for penalty abatement will be considered.
Ordering of Credits
The guidelines outline the ordering rules that apply when an eligible owner wants to claim the PTET credit on its individual or fiduciary return:
- Credits that are structural in nature and are considered by the DOT to be a reduction in tax liability, rather than a credit against the tax (for example, the credit for taxes paid to other states).
- Credits that do not have a statutory carryforward or refundable feature. If there are multiple credits of equal priority, taxpayers may claim the credits in order of maximum benefit.
- Credits may be carried forward according to their expiration dates. Should there be multiple credits with equal carry-forward durations, taxpayers are permitted to claim these credits in the order that yields the maximum benefit to the taxpayer.
- Current-year credits, starting with those with the shortest carryforward period first. If there are multiple credits with carry forwards of equal priority, taxpayers may claim the credits in order of maximum benefit.
- Refundable credits: The net excess over remaining tax liability is refunded (the PTET credit is a refundable credit).
The guidelines further explain that if “a credit is calculated as, or limited to, a percentage of the tax, the ‘tax’ for this purpose is the gross tax, less any structural credits.” They add that a double benefit for any credit claimed or to be claimed in one or more tax years is not allowed.
Retroactive Guidelines
As noted, on March 4, the DOT issued guidelines for making a retroactive PTET election for tax year 2021. To make that election, a PTE must submit Form 502PTET with all owner credit allocation details and required schedules via the Virginia Tax Online Business Services portal by September 16, 2024. The DOT will not accept retroactive tax year 2021 PTET returns after that date. There are no provisions for extensions or options for late filing. The PTET must be paid in full via the business services portal when the 2021 Form 502PTET is filed.
Because the 2021 PTET election is retroactive, no estimated payments are required.
Impact of 2021 PTET Election on Owner’s Individual Virginia Tax Return
An owner may not amend its tax year 2021 Virginia Form 760, “Resident Income Tax Return,” or Form 763, “Nonresident Individual Income Tax Return,” to claim the retroactive credit. Instead, the retroactive 2021 PTET credit will be applied to the owner’s 2023 Form 760 or 763
Estates or trusts (except those disregarded for income tax purposes) that are eligible owners of an electing PTE may claim the entire PTET credit on their fiduciary income tax returns but cannot pass any portion of the credit to their beneficiaries.
Eligible owners should wait for the electing PTE to issue Schedule VK-1 before claiming the PTET credit. If the Schedule VK-1 is issued after the due date of the owner’s tax return, the eligible owner has two options:
- Make any required extension payments and file the return within the extension period; or
- File the initial return without the credit and submit an amended return after receiving the Schedule VK-1, indicating a PTET credit.
Insight
- The final guidelines clarified several taxpayer questions, especially regarding the addback of the PTET credit.
- The final guidelines allow S corporations with resident and nonresident owners to use apportioned income to compute the tax base, which makes Virginia’s PTE election regime an option for more taxpayers.
- The retroactive 2021 PTE election would likely be disadvantageous to many taxpayers, particularly those also making the 2023 PTET election in Virginia. To the extent taxpayers are overpaid and receive PTET refunds, those refunds could be included in federal taxable income. As with any PTE election, taxpayers should examine whether the benefits outweigh the costs.
