Virginia: State Enacts PTE Tax Election and Modifies Additional Business Interest Deduction

This alert was updated on April 18, 2022.

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. 

On April 18, the Virginia Department of Taxation published Tax Bulletin 2022-6, which confirms that taxpayers should continue to file as normal for the 2021 tax year. The Department confirms in the bulletin that guidance will not be issued on how to make the 2021 PTE election until on or after October 15, 2023. Therefore, taxpayers who would like to make the Virginia PTE election for 2021 will have to do so on an amended return.

 

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%. 
 
BDO SALT professionals can help Virginia taxpayers navigate the new election and changes to the business interest deduction limitation. For more information, contact BDO.

   

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