How does Virginia's elective Pass-Through Entity Tax (PTET) work, who qualifies as an 'eligible owner' who can claim the credit, and how is the tax actually computed?

Plain-English summary

These are Department of Taxation guidelines -- not a ruling on one taxpayer's dispute -- explaining Virginia's elective Pass-Through Entity Tax ("PTET"), created by 2022 legislation (House Bill 1121 / Senate Bill 692) and expanded by 2023 legislation (House Bill 1456 / Senate Bill 1476). They cover how to make the election, compute the tax, file returns, and claim the corresponding credit for Taxable Year 2022 and after. (A separate, later set of guidelines -- P.D. 24-12 -- covers the special retroactive election available for Taxable Year 2021.)

The basic idea

A qualifying pass-through entity ("PTE" -- a partnership, LLC, professional LLC, business trust, or S corporation recognized as a separate entity for federal tax purposes) can elect to pay Virginia income tax itself, at a flat 5.75% rate, on the share of its income attributable to its "eligible owners." In exchange, each eligible owner gets a refundable credit on their own Virginia individual or fiduciary income tax return for their share of the tax the entity paid. This lets the entity's owners effectively deduct state income tax at the federal level (through the entity), which individual owners generally can't do directly because of the federal SALT deduction cap.

"Eligible owner" means a direct owner of the PTE who is a natural person, or an estate or trust (including disregarded entities like grantor trusts or single-member LLCs, so long as they're 100% owned by an individual). Only the eligible owners' share of income is subject to the PTET -- income allocable to other kinds of owners (like corporations) isn't part of the PTET base.

Making the election

A PTE elects to pay PTET for a taxable year by doing any one of:

• Making an estimated PTET payment for the year,
• Making an extension payment, or
• Filing the PTET return (Form 502PTET) by the extended due date.

Once Form 502PTET is filed, the election is binding for that year on all eligible owners -- no owner can individually "opt out." If Form 502PTET hasn't been filed yet, the entity can instead revoke the election by filing the regular Form 502. Because payments and deductions can span two taxable years, a single year's PTET election may end up requiring Form 502PTET filings (and VK-1s) for more than one year.

Computing the tax

The entity first determines its overall allocation and apportionment (using the same method as the regular Form 502), then classifies each eligible owner as a Virginia resident or nonresident (individuals under Va. Code § 58.1-302; estates/trusts under the "resident estate or trust" definition in the same section -- part-year residency isn't used for this purpose). From there:

• Resident eligible owners: their entire share of PTE income is included, regardless of the entity's apportionment percentage -- Virginia residents are taxed on all their PTE income no matter where it's earned.
• Nonresident eligible owners: only the share of income attributable to Virginia is included -- their share of ordinary ("apportionable") income times the PTE's apportionment percentage, plus their share of dividend income if the PTE is commercially domiciled in Virginia.

The computation must include everything that would otherwise flow through to eligible owners' individual returns (including guaranteed payments), but can exclude amounts properly allocable to an owner who wouldn't be taxed on it anyway (for example, non-U.S.-source income allocable to a nonresident alien partner, or certain exempt retirement income). Separately stated deductions generally carry through too, though items with a federal limit (like charitable contributions or the Section 179 deduction) are capped as if the PTE were a C corporation. Whenever the PTE deducts state/local income taxes on its federal return, it must add that amount back for Virginia PTET purposes, in the same year as the federal deduction -- even if the corresponding credit reaches the owners in a later year (illustrated in the guidelines with a worked example where a $50,000 PTET liability paid $40,000/$10,000 across two calendar years results in the deduction/addition being split the same way).

Special optional method for S corporations with mixed ownership. If an electing S corporation has both resident and nonresident eligible owners, it may elect to compute its Virginia taxable income as if all owners were nonresidents -- meaning even its resident owners' PTET base is limited to Virginia-apportioned income, rather than their full share. This is an alternative to the general rule above and can change the PTET math meaningfully for S corporations with resident owners.

Filing and paying

PTET returns (Form 502PTET) are due the 15th day of the 4th month after the close of the taxable year (April 15 for calendar-year filers), with an automatic 6-month filing extension (no application needed) -- but that extension only applies to filing, not to payment. At least 90% of the PTET due must be paid by the original due date, or a 2%-per-month extension penalty applies (capped at 12%). All filings and payments must be made electronically; there are no hardship exemptions from e-filing.

Starting with Taxable Year 2023, an electing PTE must make quarterly estimated payments if its expected PTET exceeds $1,000 for the year (Taxable Year 2022 was exempted from this requirement). The usual underpayment penalty can be avoided under one of three safe harbors in Va. Code § 58.1-504: paying at least the prior year's PTET liability, paying based on the prior year's income at current rates, or using the annualized-income method -- though the first two safe harbors are only available if the PTE also made the PTET election (and filed a full 12-month PTET return) the prior year.

Because PTET is a corporate-style entity tax, its penalties come from Article 14 (Va. Code § 58.1-450 et seq.) rather than the ordinary pass-through-entity penalty provisions: up to a 12% extension penalty, up to a 30% late-payment penalty, a flat 30% late-filing penalty (minimum $100) if the return is filed after the extended due date or not at all, and potential criminal exposure (a Class 6 felony) for a fraudulent return.

An electing PTE must also notify every owner -- eligible and ineligible alike -- that the election was made and whether they qualify as an eligible owner, and must issue each of them a Schedule VK-1.

Claiming the credit on an owner's own return

An eligible owner claims the refundable PTET credit on their individual or fiduciary income tax return once they receive their Schedule VK-1. An estate or trust that is an eligible owner may claim the full credit on its own fiduciary return, but cannot pass any portion of that credit down to its beneficiaries. If the VK-1 arrives after the owner's own filing deadline, the owner can either extend and file during the extension period, or file without the credit and amend later. Any owner who claims the PTET credit must add back their share of the state-tax deduction the PTE claimed federally, in the same year.

The credit is a refundable credit, so under the Department's established credit-ordering rules (P.D. 95-240), it's applied last -- after structural credits, non-carryforward credits, and any credit carryforwards -- with any excess refunded.

Credit for PTET paid to other states

Virginia residents may generally claim its existing nonrefundable "out-of-state credit" (Va. Code § 58.1-332) for taxes paid by a PTE under another state's substantially similar elective PTE regime, for Taxable Years 2021 through 2025. This reverses the Department's own 2021 position (P.D. 21-156), which had denied a credit for Maryland's elective pass-through entity tax -- that reversal was first announced in Tax Bulletin 22-6. It applies only to taxes substantially similar to Virginia's own PTET; it does not extend to other entity-level taxes such as non-elective franchise, privilege, business, license, occupation, or excise taxes, and it does not cover any local government's PTET even if a state collects it. The credit amount is still capped under the existing out-of-state-credit limitation formula, comparing the income taxed by the other state to the owner's Virginia taxable income.

"Reverse credit states" are a special case. Virginia has three current reverse-credit states with a substantially similar PTET: Arizona, California, and Oregon. For these states, the normal rule flips: a Virginia resident with income from one of these states ordinarily claims the credit on that state's nonresident return, not on their Virginia resident return (and vice versa for that state's residents earning Virginia income) -- unless the reverse-credit state doesn't itself allow a credit for PTET paid to Virginia, in which case the Virginia resident can claim the credit on their Virginia return after all, with proof attached.

What this means for you

Owners of a Virginia partnership, LLC, or S corporation

The PTET election can let your entity effectively pay Virginia income tax at the entity level and pass a refundable credit down to you, which can be valuable if you're affected by the federal SALT deduction cap. But the election is all-or-nothing once Form 502PTET is filed -- individual owners can't opt out -- so it should be discussed with your entity's other owners and your tax preparer before the entity locks in a filing.

Estates or trusts that are direct owners of an electing PTE

You can claim the full PTET credit on your own fiduciary return, but you cannot distribute any part of that credit to your beneficiaries -- plan your fiduciary return accordingly rather than assuming the credit flows further downstream. (This same limit is confirmed directly in a separate ruling, P.D. 24-13, involving a trust that tried to pass the credit to its beneficiaries and was told it couldn't.)

S corporations with both resident and nonresident owners

Check whether the special optional computation method (treating all owners as nonresidents for PTET purposes) produces a better result than the general allocation rule -- it's an election available specifically to mixed-ownership S corporations and isn't automatic.

Anyone with PTET paid to another state, especially Arizona, California, Maryland, or Oregon

Don't assume the credit works the same way in every state. Maryland-style states follow the general out-of-state-credit rule (claim on your Virginia resident return), but Arizona, California, and Oregon are "reverse credit states" where the credit is normally claimed on the other state's nonresident return instead.

Common questions

Q: Who counts as an "eligible owner" who can receive the PTET credit?
A: A direct owner of the pass-through entity who is a natural person, or an estate or trust (including certain disregarded entities like grantor trusts or single-member LLCs that are wholly owned by an individual). Indirect owners -- for example, beneficiaries of a trust that itself is the direct PTE owner -- are not eligible owners.

Q: Can an owner opt out of the PTET election if the entity as a whole decides to elect?
A: No. Once the electing PTE files Form 502PTET, the election is binding on all eligible owners; there's no individual opt-out.

Q: Does electing PTET replace the entity's other Virginia tax obligations?
A: No. PTET is imposed in addition to any other taxes the entity owes, including sales and use tax, employee withholding tax, and any applicable minimum taxes.

Q: I'm a Virginia resident who owns a share of a pass-through entity that pays an elective PTE-style tax to another state -- can I get a Virginia credit for that?
A: Generally yes, for Taxable Years 2021-2025, if that state's tax is substantially similar to Virginia's own PTET -- except for Arizona, California, and Oregon, which are "reverse credit states" where you'd normally claim the credit on that state's nonresident return instead of on your Virginia return.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-390.3 -- imposes the elective Pass-Through Entity Tax (PTET) at 5.75%, defines eligible owners, and allows the refundable PTET credit
• Va. Code § 58.1-332 -- nonrefundable credit for taxes paid to other states, including the subsection B "reverse credit state" rule
• Va. Code § 58.1-332.2 -- other entity-level taxes (franchise, privilege, business, license, occupation) are not covered by the out-of-state PTET credit
• Va. Code §§ 58.1-322.01 through 58.1-322.04 -- individual income modifications applied when computing PTE taxable income
• Va. Code § 58.1-302 -- defines "resident" and "resident estate or trust" for classifying PTE owners
• Va. Code § 58.1-450 et seq. / § 58.1-455 -- Article 14 corporate-style penalties and the late-filing penalty applied to PTET, instead of Article 9 penalties
• Va. Code § 58.1-504 -- estimated tax underpayment exceptions: prior-year-tax, prior-year-income-at-current-rates, and annualized-income safe harbors
• Va. Code §§ 58.1-105, 58.1-1835, 58.1-1845 -- erroneous-written-advice penalty/interest waiver if a court later disagrees with these guidelines
• Va. Code § 58.1-371 -- allows the out-of-state credit on fiduciary income tax returns
• Va. Code § 2.2-4000 et seq. (Administrative Process Act) -- these guidelines are not formal rules/regulations subject to the Act
• Va. Code § 58.1-202 -- the Tax Commissioner's general authority to supervise administration of Virginia's tax laws, under which these guidelines are issued

Prior rulings/guidance referenced (described here, not linked): Public Document 21-156 (12/29/2021) -- previously denied an out-of-state credit for Maryland's elective PTE tax, now overruled for Taxable Years 2021-2025; Tax Bulletin 22-6 -- first announced that reversal and continues to govern how to make the Taxable Year 2021 PTET election/payment; Public Document 95-240 (9/22/1995) -- establishes the ordering rules for claiming multiple Virginia tax credits.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 24-1

Original ruling text

Guidelines for the Pass-through Entity Tax

During the 2022 Session, the Virginia General Assembly enacted House Bill 1121 (2022 Acts of Assembly, Chapter 690) and Senate Bill 692 (2022 Acts of Assembly, Chapter 689), which permit a qualifying pass-through entity (“PTE”) to make an annual election to pay an elective income tax (“PTET”) at a rate of 5.75 percent at the entity level. The legislation also allows a corresponding refundable income tax credit to certain PTE owners for income tax paid by a PTE if such PTE makes the election and pays the elective income tax imposed at the entity level.

The legislation allows an individual to claim a credit for taxes paid to other states under laws that are substantially similar to the pass-through entity income tax. Effective for taxable years beginning on and after January 1, 2021, but before January 1, 2026, this overrules Public Document 21-156 (December 29, 2021), which generally denied a credit for a tax paid to Maryland under that state’s elective pass-through entity income tax. This provision only applies to taxes paid by a PTE under the law of another state that is substantially similar to Va. Cod e § 58.1-390.3. Therefore, it does not apply to any other entity-level taxes, such as any franchise, privilege, business, license, or occupation taxes described in Va. Code § 58.1-332.2.

During the 2023 Session, the Virginia General Assembly enacted House Bill 1456 (2023 Acts of Assembly, Chapter 686) and Senate Bill 1476 (2023 Acts of Assembly, Chapter 687), which removed the requirement that a PTE be 100 percent owned by natural persons or persons eligible to be shareholders of an S corporation in order to make the election to pay the PTET. This legislation also defines an “eligible owner” as a direct owner of a pass-through entity who is a natural person or an estate or trust, and states that only the pro rata or distributive share of income, gain, loss, or deduction attributable to eligible owners are subject to the PTET. These changes are effective for taxable years beginning on and after January 1, 2021.

These guidelines are published by the Department of Taxation (“the Department”) to provide guidance to taxpayers regarding the elective income tax and corresponding refundable credit as required by Va. Code § 58.1-390.3 (F). These guidelines are not rules or regulations subject to the provisions of the Administrative Process Act ( Va. Code § 2.2-4000 et seq.) and are being published in accordance with the Tax Commissioner’s general authority to supervise the administration of the tax laws of the Commonwealth pursuant to Va. Code § 58.1-202. As necessary, additional information regarding these procedures will be published and posted on the Department’s website, www.tax.virginia.gov .

These guidelines complement the Department’s existing General Provisions Applicable to All Taxes Administered by the Department of Taxation Regulation (23 Virginia Administrative Code (“VAC”) 23 VAC 10-20-10 et seq.), Individual Income Tax Regulation (23 VAC 10-110-20 et seq.), and Corporation Income Tax Regulation (23 VAC 10-120-10 et seq.). To the extent that there is a conflict between the Department’s existing guidance and the relevant laws (2022 Acts of Assembly, Chapters 689 and 690 as modified by 2023 Acts of Assembly, Chapters 686 and 687), the provisions of those laws, as interpreted by these guidelines, supersede existing guidance.

These guidelines represent the Department’s interpretation of the relevant laws. They do not constitute formal rulemaking and hence do not have the force and effect of law or regulation. In the event that the final determination of any court holds that any provision of these guidelines is contrary to law, taxpayers who follow these guidelines will be treated as relying on erroneous written advice for purposes of waiving penalty and interest under Va. Code §§ 58.1-105, 58.1-1835, and 58.1-1845.

These guidelines address how to make the pass-through entity tax election for Taxable Year 2022 and after. Please note that the ability to make the pass-through entity tax election is currently set to sunset after Taxable Year 2025. Please also note that these guidelines do not address the method by which a return must be filed, and a passthrough entity tax must be paid for Taxable Year 2021. As a result, those seeking to make the election for Taxable Year 2021 should continue to follow Tax Bulletin 22-6 . Subsequent guidance will be published by the Department regarding how to make the election for Taxable Year 2021.

Definitions

As used in these guidelines, unless the context requires otherwise:

“Credit for taxes paid other states” or “out-of-state credit” means the nonrefundable individual income tax credit allowed by Va. Code § 58.1-332.

“Electing pass-through entity” or “electing PTE” means a pass-through entity that has made the election allowed by Va. Code § 58.1-390.3.

“Eligible owner” means a direct owner of a pass-through entity who is a natural person or an estate or trust. For this purpose, a natural person also includes entities disregarded for federal tax purposes such as grantor trusts and single member limited liability companies, so long as that disregarded entity or grantor trust is 100 percent owned by a human being.

"Owner" means any individual or entity who is treated as a partner, member, or shareholder of a pass-through entity for federal income tax purposes.

"Pass-through entity" or “PTE” means any entity, including a limited partnership, a limited liability partnership, a general partnership, a limited liability company, a professional limited liability company, a business trust, or a Subchapter S corporation, that is recognized as a separate entity for federal income tax purposes, in which the partners, members, or shareholders report their share of the income, gains, losses, deductions, and credits from the entity on their federal income tax returns or make the election and pay the tax levied pursuant to Va. Code § 58.1-390.3.

“Pass-through entity tax” or “PTET” means the elective income tax imposed by Va. Code § 58.1-390.3.

“Pass-through entity tax credit” or “PTET credit” means the refundable individual and fiduciary income tax credit allowed by subsection D of Va. Code § 58.1-390.3.

Making the Election

A PTE has the option to make the election to pay PTET for the taxable year. Such election can be made by:

● Making an estimated payment of PTET for the taxable year,

● Making an extension payment of PTET for the taxable year, or

● Filing a PTET return (“Form 502PTET”) on or before the extended due date for the taxable year.

Please see the Department’s website, www.tax.virginia.gov , for methods by which the estimated and extension payments may be made, as well as the methods by which the PTET return may be filed.

If a Form 502PTET has not been filed for the taxable year, the PTET election can be revoked by filing the Form 502. Once Form 502PTET is filed, the election is binding for that taxable year.

A PTET election for one taxable year may require the filing of Form 502PTET returns and Schedule VK-1s for more than one taxable year if estimated, extension, and final payments are made, and related state tax deductions are claimed, over two taxable years.

Each electing pass-through entity decides how to obtain consent from its eligible owners; provided, however, the election is binding on all the eligible owners once the election is made. For S corporations, this includes the choice whether to take advantage of the special option on how to compute their PTET, described below. An eligible owner does not have the option to “opt out” of an entity’s election with the Department. An owner, officer, or employee of the PTE who is authorized to act on behalf of the PTE in tax matters must sign the PTET return. By signing the return, the signer is declaring that they are the authorized representative of the PTE. Because the PTET return must be filed electronically, the return must be signed using the electronic signature procedures established by the Department. Please see the Department’s website for more information.

Which PTEs Qualify to Make the Election

Any PTE can make the PTET election. However, only the pro rata or distributive share of income, gain, loss, or deduction attributable to eligible owners is subject to the PTET.

Pass-through Entity Taxable Income and Tax

Allocation and Apportionment

The first step in computing the PTET is determining the allocation and apportionment of the PTE’s income. Please see the Form 502 Instructions for information regarding how to determine the PTE’s allocation and apportionment.

Classifying Owners

The second step is determining whether each eligible owner should be classified as a resident or nonresident of Virginia.

With respect to individual owners, they are residents if they meet the definition of “resident” in Va. Code § 58.1-302, for the taxable year. All other individual owners should be treated as nonresidents. For the purposes of the PTET computation, eligible owners may not be classified as part-year residents.

With respect to estate or trust owners, they are residents if they meet the definition of “resident estate or trust” in Va. Code § 58.1-302, for the taxable year. Any estate or trust partner that does not meet this definition is a nonresident owner.

With respect to eligible owners that are disregarded entities, the classification should be based upon the individual, estate, or trust that owns the disregarded entity.

Effect of Classification on Allocation and Apportionment: General Principles

Once that classification is made, the Virginia taxable income of an electing PTE is determined by adding the following:

● Each resident eligible owner's share of the electing PTE’s income or loss, subject to the modifications to the PTE’s income as described in Va. Code §§ 58.1 322.01, 58.1-322.02, 58.1-322.03, and 58.1-322.04. This is because Virginia residents are taxable on all of their PTE income regardless of the PTE’s allocation and apportionment.

● Each nonresident eligible owner's share of the PTE’s income or loss, subject to the modifications to the PTE’s income as described in Va. Code §§ 58.1-322.01, 58.1-322.02, 58.1-322.03, and 58.1-322.04, that is attributable to Virginia.

In determining the share of such income or loss that is attributable to Virginia, the electing PTE adds:

● Each nonresident eligible owner’s share of such income or loss other than dividend income (“apportionable income”) multiplied by the PTE’s apportionment percentage; and

● Each nonresident eligible owner’s share of dividend income (“allocable income”) if the PTE is commercially domiciled in Virginia.

An electing PTE’s calculation of its PTE taxable income must include all items of income, gain, loss, or deduction, to the extent they would flow through and be included in the income of eligible owners that are taxable under Va. Code §§ 58.1-320 and 58.1360, as applicable, including guaranteed payments. However, the electing PTE can exclude income from the calculation of PTE taxable income to the extent that the PTE can establish that the amount is properly allocable to an eligible owner who is not subject to tax on such amount under Va. Code §§ 58.1-320 and 58.1-360, as applicable. Two examples are (1) income that is not U.S. sourced and is allocable to nonresident alien partners and, therefore, not included in federal adjusted gross income under the Internal Revenue Code, and (2) retirement income of former partners that is exempt from nonresident state taxation under 4 U.S.C § 114.

Separately stated items of deduction are generally included when calculating each eligible owner's share of the PTE's taxable income. However, any deduction that is subject to a federal limitation, such as the deduction for charitable contributions and the Section 179 deduction, will be limited to what is allowed under federal law for a C corporation.

Electing PTEs must make an addition for any state and local income taxes paid or incurred during the taxable year to the extent that the electing entity deducted such taxes in determining its federal taxable income. The addition should occur in the same taxable year as the federal deduction, even if such taxable year is different from that in which the PTET credit is distributed to the PTE owners.

Example

Partnership ABC is a calendar year, cash-basis taxpayer. It makes a PTET election for Taxable Year 2023. It determines that it owes PTET in the amount $50,000, of which $40,000 has been paid as estimated tax payments throughout Taxable Year 2023, and $10,000 when it files its PTET return in the spring of 2024. The partners would claim their pro rata share of the $50,000 PTET credit on their Taxable Year 2023 returns. Partnership ABC would take the $40,000 federal deduction on its Taxable Year 2023 federal return and the corresponding addition, also in the amount of $40,000, on its Taxable Year 2023 Virginia PTET return. The remaining deduction and associated addition would be claimed on its Taxable Year 2024 return.

Effect of Classification on Allocation and Apportionment: Special Option for Certain S Corporations

If the electing PTE is an S corporation and has both resident and nonresident eligible owners, the electing S corporation has the option to compute its Virginia taxable income as if all of its owners are nonresidents. Therefore, as an alternative to the above, the Virginia taxable income of an electing S corporation with both nonresident and resident owners may be determined by adding the following:

● Each resident eligible owner's share of the electing S corporation’s income or loss, subject to the modifications to the S corporation’s income as described in Va. Code §§ 58.1-322.01, 58.1-322.02, 58.1-322.03, and 58.1-322.04 that is attributable to Virginia.

● Each nonresident eligible owner's share of the S corporation’s income or loss, subject to the modifications to the S corporation’s income as described in Va. Code §§ 58.1-322.01, 58.1-322.02, 58.1-322.03, and 58.1-322.04, that is attributable to Virginia.

In determining the share of such income or loss that is attributable to Virginia, the electing S corporation adds:

● Each eligible owner’s share of such income or loss other than dividend income (“apportionable income”) multiplied by the PTE’s apportionment percentage; and

● Each eligible owner’s share of dividend income (“allocable income”) if the PTE is commercially domiciled in Virginia.

All the other principles described the “Effect of Classification on Allocation and Apportionment: General Principles” section above remain the same for S corporations choosing to take advantage of this optional approach.

Computing the Tax

An electing PTE calculates its Virginia income tax by multiplying its Virginia taxable income by 5.75 percent. Credits are generally passed through to the eligible owners and are not applied against the PTET. However, the following may be used to reduce the amount due with the PTET return or, if applicable, generate a refund to the electing PTE:

● Any payments that have formerly been made for the taxable year, including estimated and extension payments, and

● Any credit that permits the PTE to elect to receive and claim the credit at the entity level rather than passing through the credit to the owner, such as the Research and Development Expenses Tax Credit and the Motion Picture Production Tax Credit, but only if the PTE so elects to receive and claim the credit at the entity level.

This PTET is in addition to any other taxes imposed on the entity, including sales and use taxes, withholding taxes with respect to employees, and minimum taxes in lieu of income taxes.

Filing the Annual PTET Return

Electing PTEs are required to file their returns and the accompanying schedules and make any tax payments electronically. Please see the Department’s PTET return instructions for more information regarding how to make payments and file returns electronically. No hardship exemptions are available for electronically filing PTET returns.

PTET returns (“Form 502PTET”) are due by the 15th day of the 4th month following the close of the taxable year. For calendar year filers, that means April 15. Virginia allows an automatic 6-month filing extension for PTEs. No application for extension is required. For calendar year filers, that means that they have until October 15 to file their return on extension. However, this six-month extension is only for filing the return and does not extend the due date for payment of taxes. As a result, an electing PTE must pay at least 90 percent of its PTET due by the original due date for filing the return. If Form 502PTET is filed within the automatic extension period, but less than 90 percent of the tax liability was paid by the original due date, an extension penalty will apply. The extension penalty is imposed at the rate of 2 percent per month or part of a month from the original due date through the date of full payment, the date the return is filed, or the extended due date, whichever is earlier. The maximum penalty is 12 percent of the tax due with the return.

When an electing PTE files an annual Virginia income tax return reflecting an overpayment, the Department will refund the overpayment of PTET to the electing PTE. Only the electing PTE is entitled to request a refund of an overpayment of PTET; the individual owners cannot request a refund.

An electing PTE must notify its owners that the election has been made and indicate whether they are an eligible owner entitled to receive the information and benefits of the election. In addition, an electing PTE must provide a Schedule VK-1 to each of its owners, including both eligible and ineligible owners, with information regarding the pass-through of income and related deductions and credits so that the owners can complete their own Virginia tax returns.

On its return, an electing entity must report its total PTET. The total amount of PTET credits reported by an electing entity shall not exceed the total PTET paid by the electing PTE.

The electing PTE must provide sufficient information on the Schedule VK-1s in its return to identify all PTET credit-eligible taxpayers and their credit amounts. If such identifying information is not provided, the otherwise eligible owners will not be entitled to utilize the PTET credit on their Virginia income tax returns.

In no case may the PTET credit be distributed to ineligible owners. The amount of PTET credit that is distributed to each eligible owner is equal to the amount of PTET paid by the PTE on the income distributed to each of them. Therefore, the credit must be allocated to nonresident eligible owners based on only their distributive or pro rata share of income attributable to Virginia. If the electing PTE’s total PTE taxable income is zero or less, its eligible owners are not entitled to any PTET credits. Instead, the electing PTE may file Form 502PTET to request a refund of any PTET estimated tax payments it made.

Example

Partnership XYZ makes the PTET election for the taxable year and has $100,000 in income upon which it pays PTET in the amount of $5,750. It has three partners, all of whom are Virginia residents: Partner X receives a 50 percent share of the income, Partner Y receives 40 percent, and Partner Y receives 10 percent. Accordingly, the amount of credit that each partners receives is:

Partner X: $5,750 x 50% = $2,875

Partner Y: $5,750 x 40% = $2,300

Partner Z: $5,750 x 10% = $575

Example

Partnership XYZ makes the PTET election for the taxable year and has $100,000 in income upon which it pays PTET in the amount of $5,750. It has three partners: Partner X is a resident and receives a 50 percent share of the income, Partner Y is a resident and receives 40 percent of the income, and Partner Z is a nonresident and receives 10 percent of the income. Partnership XYZ’s apportionment percentage is 75 percent, and it receives no dividend income. Accordingly, the amount of credit that each partner receives is:

Partner X: $50,000 x 100% x 5.75 % = $2,875

Partner Y: $40,000 x 100% x 5.75 % = $2,300

Partner Z: $10,000 x 75 % x 5.75 % = $431.25

Estimated Tax Payments

For Taxable Year 2022, an electing PTE is not required to make estimated payments of PTET and will not be subject to an addition to tax charge for not making estimated payments. If a PTE wishes to make a payment during Taxable Year 2022, it may do so. However, such payment is not required, and taxpayers may wait to make payments until the original due date of the return, when they should either make a return payment or, if filing on extension, an extension payment.

For taxable years after Taxable Year 2022, an electing PTE is required to make estimated payments if its PTET for the taxable year can reasonably be expected to exceed $1,000. Estimated payments for electing PTEs will be based upon the rules set forth in Article 20 ( Va. Code § 58.1-500 et seq.). As a result, for calendar year filers required to make four quarterly installments, estimated payments must be made to the Department as follows: 25 percent by April 15, 25 percent by June 15, 25 percent by September 15, and 25 percent by December 15. For non-calendar year filers required to make four quarterly installments, the electing PTE is required to pay 25 percent of the amount due to the Department by the 15th day of the 4th month following the beginning of its fiscal year. Subsequent installments are payable by the 15th day of the 6th month, the 15th day of the 9th month, and the 15th day of the 12th month following the beginning of its fiscal year. In case of any underpayment of estimated payments by a PTE, an addition to tax will apply at the established interest rate for underpayments unless one of the following exceptions in Va. Code § 58.1-504 applies:

• Prior Year’s Tax Exception: Generally, this exception applies if the PTE paid an amount that was equal to or more than the PTET shown on its previous year return. However, the PTE must have filed a PTET return showing a tax liability for the preceding taxable year and that taxable year must have consisted of 12 months. Therefore, PTEs that did not make the PTET election for the preceding taxable year may not avail themselves of this exception.

• Tax on Prior Year’s Income Using Current Year’s Rates Exception: Generally, this exception applies if the amount the PTE paid is equal to or greater than the PTET figured by using the current year’s rates but based on the facts shown on the prior year’s PTET return and the law that applies to the prior year. A PTET return must have been filed for the prior year. Therefore, PTEs that did not make the PTET election for the preceding taxable year may not avail themselves of this exception.

• Tax on Annualized Income Exception: Please see Va. Code § 58.1-504(D)(3) and the Form 500C Instructions for more information on how this exception applies.

Nonresident Withholding Payments and Composite Payments

Electing PTEs must make nonresident withholding payments on behalf of its nonresident ineligible owners. However, electing PTEs should not make nonresident withholding payments or payments associated with composite returns (“composite payments”) on behalf of its nonresident eligible owners. If nonresident withholding payments on behalf of its nonresident eligible owners were made before the PTE made the PTET election, the PTE should claim the withholding payment on Form PTET. If composite payments on behalf of its nonresident eligible owners were made before the PTE made the PTET election, the PTE should request a refund of any such payments made. Please see the Department’s website for guidance on this. If the PTE would prefer to request reallocation of composite payments to its PTET return, it may do so by submitting a written request to the Virginia Department of Taxation, Customer Services, P.O. Box *, Richmond, VA 23218-1115. The request should be made as far in advance of filing the PTET return as possible.

Filing Requirements for Nonresident Eligible Owners of an Electing PTE

An electing PTE may not file a composite return on behalf of its nonresident eligible owners. If a nonresident eligible owner’s only Virginia-source income is through an electing PTE that fully pays the PTET, such nonresident eligible owner is permitted, but not required, to file a Virginia nonresident return.

Penalties

Pursuant to Va. Code § 58.1-390.3(F), the penalties for electing PTEs are based upon the corporate penalties in Article 14 ( Va. Code § 58.1-450 et seq.) instead of the penalties in Article 9 ( Va. Code § 58.1-390.1 et seq.).

If the PTET return is filed within the 6-month extension, but the electing PTE failed to pay 90 percent of the tax due by the original due date, then the PTE is subject to an extension penalty of 2 percent per month or fraction of a month thereof from the original due date through the date of filing of the return, the date of full payment, or the extended due date, whichever is earlier. The maximum extension penalty is 12 percent of the tax due. If the full amount is not paid when the return is filed, the late payment penalty will be assessed at the rate of 6 percent per month up to a maximum of 30 percent of the tax due:

● In the case of a Form 502PTET filed within the extension period, from the date of filing through the date of payment, or

● In the case of a Form 502PTET filed on or before the original due date of the return, from the date of the original return due date through the date of payment.

If the PTET return is filed after the extended due date or is not filed at all, the extension provisions do not apply, and the PTE is subject to the late filing penalty ( Va. Code § 58.1-455) equal to 30 percent of the tax due. In no case will the penalty for failure to file timely be less than $100, and this minimum $100 penalty applies whether or not tax is due for the period covered by the return. The late payment penalty does not apply to the extent that the taxpayer is already subject to the late filing penalty.

Civil and criminal penalties may be imposed for filing a fraudulent return. The criminal penalty for filing a fraudulent return is a Class 6 felony ( Va. Code §§ 58.1-451 and 58.1452). Interest on the unpaid balance of any tax and penalty is charged at the underpayment rate established by IRC § 6621, plus 2 percent, from the due date until paid.

Filing a Return by an Eligible Owner

An eligible owner may claim a refundable PTET credit against their Virginia individual income tax or fiduciary income tax. An estate or trust, other than a trust that is disregarded for income tax purposes, that is an eligible owner of an electing PTE is allowed to claim the full PTET credit that it receives on its fiduciary income tax return, but it is not permitted to distribute any portion of the credit to its beneficiaries. Eligible owners must wait until the electing PTE issues the Schedule VK-1 before claiming the PTET credit. If the electing PTE does not issue the Schedule VK-1 until after the due date for the owner’s return, the eligible owner may (1) make any necessary extension payments and file the return during the extension period or (2) file the original return without claiming the credit and then file an amended tax return once the Schedule VK-1 showing a PTET credit is received. Eligible owners of an electing PTE who claim the PTET credit on their individual or fiduciary income tax return must make an addition equal to the eligible owner’s proportionate share of any deduction for state and local income taxes paid or incurred by the pass-through entity during the same taxable year.

Example

Partnership ABCD is a calendar year, cash-basis taxpayer. It makes a PTET election for Taxable Year 2023. It has four partners, all of whom are Virginia residents. Each partner receives an equal share of the income. Partnership ABCD determines that it owes PTET in the amount $50,000, of which $40,000 was paid as estimated tax payments throughout Taxable Year 2023, and $10,000 was paid when it files its PTET return in 2024.

Partnership ABCD should claim the $40,000 federal deduction on its Taxable Year 2023 federal return and the corresponding addition, also in the amount of $40,000, on its Taxable Year 2023 Virginia PTET return. The partners should claim their pro rata share of the $50,000 PTET credit on their Taxable Year 2023 individual returns: each partner would claim a PTET credit in the amount of $12,500 and would be required to make an addition of $10,000, equal to their share of the $40,000 federal deduction that must be claimed as an addition on the Virginia return. The remaining $10,000 deduction and the associated $10,000 addition would be claimed on Partnership ABCD’s Taxable Year 2024 return. On their Taxable Year 2024 individual returns, the partners would claim their pro rata share of the remaining $10,000 Taxable Year 2023 PTET addition ($2,500).

Credits are claimed on an eligible owner’s return in accordance with Public Document 95-240 (September 22, 1995). As a result, the following ordering rules apply:

1. Credits that are structural in nature and are considered by the Department to be a reduction in tax liability, rather than a credit against the tax. An example is the nonrefundable credit for taxes paid to other states (discussed below).

2. Credits that do not have a statutory carryforward or refundable feature. Where there are multiple credits of equal priority, taxpayers may claim them in the order in which they receive the maximum benefit.

3. Credit carryforwards to the taxable year, in the order of those carryforwards which are scheduled to expired first. Where there are multiple credits with carryforwards of equal length, taxpayers may claim them in the order in which they receive the maximum benefit.

4. Current year credits, based on the order of those with the shortest carryforward period first. Where there are multiple credits with carryforwards of equal priority, taxpayers may claim them in the order in which they receive the maximum benefit.

5. Refundable credits. The net excess over remaining tax liability is refunded. The PTET credit is a refundable credit.

Where a credit is calculated as, or limited to, a percentage of the tax, the “tax” for this purpose is the gross tax, less any structural credits. A double benefit for any credit claimed or to be claimed, in one or more taxable years, is not permitted.

Credit for Taxes Paid to Other States

For Taxable Years 2021 through Taxable Year 2025, taxpayers may claim Virginia’s nonrefundable credit for taxes paid to other states (“out-of-state credit”) on their individual income tax return for certain taxes paid by a PTE under another state’s substantially similar PTE tax structure. As explained in Tax Bulletin 22-6, this provision of the legislation overrules Public Document 21-156 (December 29, 2021), which generally denied a credit for a tax paid to Maryland under that state’s elective PTET. This provision only applies to taxes paid by a PTE under the law of another state that is substantially similar to Va. Code § 58.1-390.3. Therefore, it does not apply to any other entity taxes, such as any non-elective franchise, privilege, business, license, occupation, excise, or unincorporated business taxes described in Va. Code §§ 58.1332 and 58.1-332.2. The credit also does not apply to PTET imposed by any city, county, regional, or other local taxing jurisdiction, regardless of the fact that such local PTET may be collected by a state. For the purposes of determining the out-of-state credit, the other state’s PTET should be distributed to each of the PTE’s owners in the same proportion as it is distributed pursuant to the other state’s PTET law, whether by credit, subtraction, or some other mechanism.

However, even if PTET is allocated by the PTE to its eligible owners, the eligible owners cannot necessarily claim full out-of-state credits for the allocated PTET. Instead, the credit for PTET may not exceed the limitation specified in Va. Code §§ 58.1-332(A)(3), which is based upon a ratio comparing the income upon which the other state’s tax was computed with the Virginia taxable income upon which the Virginia individual income tax was computed. Generally, the income upon which the other state’s tax was computed will be the amount of income reported on the nonresident individual income tax return, after sourcing and apportionment. However, in the case of a state using a subtraction or deduction-based PTET rather than a credit-based PTET, the income upon which the other state’s tax was computed will be the sum of (1) the amount of taxable income reported on the nonresident individual income tax return, after sourcing and apportionment and (2) the amount of taxable income on which the PTE paid PTET to the other state on the individual’s behalf, after sourcing and apportionment, which will typically equal the amount of subtraction or deduction that they are receiving from the PTE.

The out-of-state credit may also be claimed on fiduciary income tax returns pursuant to Va. Code § 58.1-371. Except as noted below regarding reverse credit states, the out-of-state credit is limited to Virginia resident returns only.

Reverse Credit States

When a state practices reciprocity with Virginia pursuant to Va. Code § 58.1-332(B), a Virginia resident receiving income from that state may typically claim an out-of-state credit on that state's nonresident income tax return and is prohibited from claiming a credit on his or her Virginia resident income tax return. Similarly, a resident of one of these states receiving income from Virginia may typically claim an out-of-state credit on Virginia’s nonresident income tax return but not on the other state’s resident income tax return. States that practice this kind of reciprocity are referred to as “reverse credit states” because they reverse the normal rule that out-of-state credits are claimed only on resident returns.

Currently, there are three reverse credit states with a substantially similar PTET: Arizona, California, and Oregon. Virginia is required to follow subsection B of Va. Code § 58.1-332 with respect to its PTET and the PTET of these reverse credit states. As a result, a Virginia resident may not claim an out-of-state credit for PTET paid to one of these reverse credit states on the Virginia return and should instead claim a credit on the other states’ nonresident income tax return for PTET paid to Virginia. However, if a reverse credit state does not allow an out-of-state credit for PTET paid to Virginia, Virginia residents may then claim a credit on the Virginia return, provided that documentation is attached to the Virginia return to verify that the other state disallows the out-of-state credit to Virginia residents. Similarly, a resident of a reverse credit state may claim an out-of-state credit for PTET paid to such reverse credit state on his or her Virginia return, provided that no out-of-state credit has been claimed on his or her return filed with the other state.

The credit may not exceed the limitation specified in Va. Code §§ 58.1-332(B), which is based upon a ratio comparing the income subject to Virginia individual income tax to the entire income upon which the other state’s tax was imposed. Generally, the income upon which the other state’s tax was computed will be the amount of income reported on the resident individual income tax return. However, in the case of a state using a subtraction or deduction-based PTET rather than a credit-based PTET, the income upon which the other state’s tax was computed will be the sum of (1) the amount of taxable income reported on the resident individual income tax return and (2) the amount of taxable income on which the PTE paid PTET to the other state on the individual’s behalf, which will generally equal the amount of subtraction or deduction that they are receiving from the PTE.

Additional Information

These guidelines are available online in the Laws, Rules & Decisions section of the Department’s website, located at www.tax.virginia.gov . For additional information, please contact the Department at (804) *.

Approved:

Craig M. Burns

Tax Commissioner

Related Documents

21-156

22-6

95-240