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Update: On April 15, 2022, the Virginia General Assembly established a new elective PTE tax. This legislation allows qualifying PTEs to be taxed at the entity level on their income, rather than requiring owners to be taxed on such income. It also allows taxpayers to claim a credit for taxes paid to another state with certain similarly structured PTE tax on their Virginia return. Tax Bulletin 22-6 offers more details.
The federal Tax Cuts and Jobs Act of 2017 (TCJA) imposed a $10,000 limit on the amount of non-business State and Local Taxes (SALT) that individuals can deduct for federal income tax purposes, regardless of how much is actually paid. However, there was no similar limitation put into place for state and local taxes attributable to a trade or business.
In response, over the last couple of years over 20 states have enacted an election for Pass-Through Entities (PTE) aimed at circumventing the $10,000 SALT deduction limitation enacted by the TCJA, including Maryland. Generally, PTE owners can have their net income taxed at the entity level instead of at the individual partner level thereby creating an entity-level tax deduction. This has become known as the “PTE SALT cap workaround.”
In August 2021, the Virginia Society of Certified Public Accountants (VSCPA) Tax Advisory Committee requested a ruling from the Virginia Department of Taxation on the PTE SALT cap workaround and related taxes paid to other states, especially the neighboring State of Maryland where many Virginia business owners live and work (and vice versa).
In the request by VSCPA, it was suggested that Virginia should allow the credit as Virginia resident taxpayers are subject to Maryland income tax on Maryland source income, regardless if the PTE election is made or not. VSCPA’s letter stated:
“…many Virginia taxpayers, many of whom are small business owners, will be impacted by the Maryland PTE election. Some of the Virginia owners, being minority partners and/or shareholders will have the election made by the entity by being outvoted by their Maryland co-owners. While they may receive a federal benefit, it will be at the cost of having to pay tax to two states on the same income unless TAX confirms that based upon the mechanics of the Maryland PTE election, and the income subject to tax at the entity and individual levels in Maryland, that Virginia would in fact, allow a deduction for taxes paid to Maryland on the same income.”
After initially determining that Virginia taxpayers are eligible to claim the credit for PTE tax paid by S Corporations only, the Virginia Department of Taxation (TAX) issued an amendment to include out-of-state credits for partnership returns filed in other states using the SALT cap workaround effective for tax years beginning Jan. 1, 2021. Further, the bill permits qualifying PTEs to make an annual election in taxable years 2021 through 2025 to pay an elective income tax at a 5.75% rate.
We are available to discuss the tax opportunities related to Virginia’s pass-through entity state and local workaround. Click the button below to schedule a consultation.
