Virginia’s 2021 retroactive pass-through entity tax election

Background

In 2022, Virginia enacted H.B. 1121/S.B. 692 (the Legislation) which permits a qualifying pass-through entity (PTE) to make an annual election to pay an elective pass-through entity tax (PTET) at a rate of 5.75% at the entity level for tax years beginning on or after Jan. 1, 2021, but before Jan. 1, 2026. The legislation also allows a corresponding refundable income tax credit to certain PTE owners for income tax paid by a PTE.

The Legislation was passed in 2022, allowing for a retroactive application of the election for 2021 (the Election), but Virginia advised taxpayers to wait for further guidance on how to make the Election due to the timing of the Legislation. (See: Virginia Tax Bulletin 22-6)

As a result, Virginia began issuing guidance earlier this year regarding the process to make the Election along with other considerations.

2021 retroactive PTET election by the PTE

Election deadline

• The return (2021 Form 502PTET) must be filed by Sept. 16, 2024, and Form 502 cannot be used to make the Election. There are no extensions or late filing options.

How to make the election and filing the 2021 return

• For taxable year 2021, a PTE can make the Election and pay the 2021 PTET by submitting 2021 Form 502PTET, including all owner credit allocation information, using Virginia’s Business Online Services on or before Sept. 16, 2024, and making all payments electronically either prior to or at the time the 2021 Form 502PTET is submitted.

Consent and notification to eligible owners

• Each electing PTE must obtain consent from its eligible owners in a manner chosen by the PTE.
• The election is binding on all eligible members once the election is made and an eligible member does not have the option to “opt out” of the entity’s election.
• An electing PTE must notify its owners (1) that the election has been made and (2) whether or not they are an eligible owner entitled to receive the information and benefits of the election.
• The FAQ published on May 8, 2024, indicates PTEs can use any format to notify owners of their 2021 PTET credits, as long as it includes the eligible owner’s share of the retroactive credit and instructions for claiming the credit on their 2023 return. Please note that PTEs should not add 2021 PTET credit information to 2023 VK-1s.

Ownership changes since 2021

• Per the guidance, the PTE has the option of distributing the 2021 PTET credit to eligible owners as they existed in 2021 or in 2023.

2021 retroactive PTET election considerations for eligible owners

Filing a return by an eligible owner

• After the PTE has timely filed its return and paid any PTET owed, eligible owners can claim any applicable credit on their 2023 income tax returns.
• Owners are not allowed to amend their 2021 owner returns to claim the retroactive 2021 PTET credit. Rather, the retroactive credit must be reported exclusively on the owner’s 2023 return after receiving notification of its share of the 2021 credits from the PTE.
• The guidance states “while reported on a 2023 owner return and while no interest will generally be paid relating back to 2021, the retroactive 2021 PTET credit is based upon the owner’s and the PTE’s Taxable Year 2021 taxes...”

Ordering of refundable credits and tax:

• Per the guidance, Virginia does not have a prescribed order in which it applies the PTET credit and income tax payments. Rather, Virginia applies all refundable credits simultaneously, following the application of current year credits; there is no prescribed order dictating which refundable credits are applied first. PTET credits, extension payments, estimated payments and tax withholdings are all considered refundable credits.

What’s next?

Virginia’s guidance indicates that reporting the 2021 PTET credit exclusively on an owner’s 2023 return rather than allowing for amended returns is a filing convenience to taxpayers. However, the excess credit received in 2023 because of the Election may generate a refund for a taxpayer depending on its unique facts and circumstances (e.g. estimated payments made, if any).

As such, businesses should reach out to their Baker Tilly tax advisor to discuss the impact 0f making the Election and the taxability of a refund, if any, for eligible owners.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.