Virginia Pass-Through Entity Tax Election Draft Guidelines – What You Need to Know Before Year-End

On October 31, 2022, the Virginia Department of Taxation (DOT) issued DRAFT Guidelines for the Pass-through Entity Tax (draft guidelines). Virginia enacted its elective pass-through entity (PTE) tax regime on April 11, 2022, making the election available for tax years beginning on and after January 1, 2021, but before January 1, 2026. However, upon enactment, there were many unanswered questions on how the election would be implemented, and the DOT was charged with issuing guidelines.

The draft guidelines address how to make Virginia’s PTE tax (PTET) election for tax years 2022 through 2025. The DOT states that it will issue guidelines for tax year 2021 at a later date. Until such guidance is issued, Tax Bulletin 22-6 should be consulted with respect to tax year 2021. By law, the DOT has until October 15, 2023, to promulgate guidelines with respect to the 2021 tax year.

For the years covered, the draft guidelines clarify what constitutes a “qualifying” PTE tax election, how to compute the tax base, and how Virginia residents should apply the out-of-state tax credit (OSTC) for income taxes paid by the PTE to other states – including guidance on how the Virginia OSTC applies for so-called “reverse” credit states (e.g., California).

The draft guidelines also reiterate that only entities which are 100% owned by “natural persons” may make the election, with the exception that entities that are disregarded for federal income tax purposes and owned by a human being (such as grantor trusts and single-member limited liability companies) may also be owners of a qualifying PTE.

Other key takeaways about the draft guidelines include:

• The tax is computed on each resident owner’s share of the electing PTE’s income or loss from all sources, subject to modifications, plus each nonresident owner’s share of the PTE’s income or loss, subject to modifications, that is attributable to Virginia (i.e., the PTE’s income or loss apportioned to Virginia).
• Payments for the 2022 PTE tax may be made before the end of the year. For tax year 2022, there are no estimated payment penalties.
• The election is officially made each year by filing a new PTE form, Virginia Form 502PTET. Once the form is filed (either by the original or extended due date), the election for that tax year is binding.
• Nonresidents may choose not to file a Virginia individual income tax return if the owner’s only Virginia source income was due to the PTE and PTE tax covers their share of Virginia tax.  

The draft guidelines also state that no composite filing is permitted by an electing PTE. The guidelines confirm that nonresident withholding payments made before the PTE made the PTET election may be claimed on Form 502PTET. If composite payments were made before the PTE made the PTET election, the guidelines state a refund should be requested. The draft guidelines also provide a method to have composite payments reallocated to PTET payments by written request.

Insights

The draft guidelines appear to address many of the questions that PTEs and their owners had for the DOT since the legislation was enacted. However, taxpayers should be mindful that the guidelines are not final. The draft guidelines do not have the force and effect of law and could be changed before they are finalized. Nevertheless, for taxpayers seeking to make payments before the end of the year, they may be the best available guidance from the DOT.