VA Enacts PTE Tax Election and Business Interest Deduction

Governor Youngkin on April 11, 2022, signed S.B. 692 and H.B. 1006 into law. The former establishes an elective pass-through entity (PTE) tax regime in Virginia, making the commonwealth the 24th state to enact a workaround to the federal $10,000 state and local tax (SALT) deduction cap. The latter increases Virginia’s additional business interest deduction from 20% to 30%, effective for tax years beginning on or after January 1, 2022.

The PTE Tax Election

Effective for tax years beginning on and after January 1, 2021, a “qualifying pass-through entity” can make an annual election to be taxed at the entity level. Virginia’s new law defines a “qualifying pass-through entity” as a PTE that is 100%-owned by natural persons, or in the case of an S corporation, 100%-owned by natural persons or other persons eligible to be shareholders in an S corporation.

The format and procedures to make the election are to be made available at a later date—specifically, for tax years beginning on or after January 1, 2021, the legislation provides that the election will be made in a format, and under procedures, to be determined by the Department of Taxation. However, the legislation does specify that the date to make the election for 2021 can be “no earlier than one year after the extended due date for filing the applicable return.” No interest will accrue on any underpayments or overpayments attributable to making the Virginia PTE tax election with respect to tax year 2021.

The election for tax years beginning on or after January 1, 2022, and before January 1, 2026, will be an annual election made with the qualifying PTE’s timely filed return by due date, including any extensions.

The elective PTE tax rate is statutorily set at 5.75%, which is currently Virginia’s highest individual income tax rate. Owners of electing PTEs are entitled to a refundable credit to offset their Virginia income tax liability. However, both the electing PTE and the individual owners will be required to add-back their respective federal state tax deductions attributable to the Virginia elective PTE tax. The electing PTE is entitled to all credits, deductions and other adjustments that owners of PTEs would otherwise be entitled to receive under Virginia’s income tax code had the PTE not made the election.

For tax years beginning on or after January 1, 2021, and before January 1, 2026, the new law also provides Virginia resident owners with an “other state tax credit” for the amount of state income taxes paid by an electing PTE to another state that are substantially similar to Virginia’s new law.

Additional Business Interest Deduction

 Although Virginia conformed to the 2017 Tax Cuts and Jobs Act’s (TCJA) amendments to the Internal Revenue Code Section 163(j) business interest deduction limitation, the state did not conform to the subsequent increase to the limitation for the 2019 and 2020 tax years from 30% to 50% under the 2020 CARES Act. Virginia has allowed an additional 20% business interest deduction. For tax years beginning on or after January 1, 2022, H.B. 1006 increases Virginia’s additional individual and corporate income tax deduction for business interest expense disallowed as a deduction under Section 163(j) from 20% to 30%.

Insights

  • Although S.B. 692 was enacted on April 11, it does not become effective until July 1, 2022. As a result, taxpayers and practitioners will need to work with the Department regarding estimated tax payments, the 2021 election and extensions, among other matters.

  • S.B. 692 is light on details compared to other states that have enacted similar elective PTE tax  regimes. It provides the Department with broad authority to fill in the many gaps with administrative guidance to implement the new elective PTE tax.

  • Stay tuned for further updates once the Department issues guidance, forms and instructions. It is likely that the Department will also create an internet portal to assist PTEs and owners with making elections and filings. Based on informal discussions, the Department has indicated that amended returns may needed to be filed for 2021.

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