Virginia Enacts New Pass-Through Entity Tax Legislation: What does this mean?
How are pass-through entities taxed?
A pass-through entity (PTE) is a status that a business chooses for tax purposes. Therefore, a business elects to be taxed as a PTE. However, not every company can elect to be taxed as a pass-through entity. LLCs, S-Corporations, partnerships run by life partners (for example, husband and wife), and sole proprietorships are eligible for being taxed as a PTE, provided owners decide to elect this tax status. Publicly traded partnerships or companies do not qualify to be taxed as PTEs. The same can be said about an entity permitted or legally obliged to be in a combined reporting group.
So, how are PTEs taxed? Usually, a business pays its tax liabilities as corporate tax while its owners pay their individual income tax rates. They also pay dividend tax whenever they receive dividends. However, when they choose to be taxed as a pass-through entity, business income is directly transferred to the owners or partners in the case of a partnership. This means that income from the business is taxed as individual income tax, and the company is spared from paying corporate tax rates. In the end, double taxation is avoided for business owners.
However, Virginia has passed a new rule that will change how pass-through entities are taxed. This means that such businesses registered in Virginia won’t be taxed as I described above anymore. Below, I provide the details about this recent change in Virginia.
What are the new pass-through entity tax changes in Virginia?
Recent news headlines featured Virginia’s 2022 General Assembly that enacted a new elective pass-through entity (“PTE”) tax that could benefit eligible businesses and their owners. And in this article, I explain how and when these changes can be implemented.
Under the new tax legislation, a Virginia qualifying pass-through entity (PTE) may make an annual election to pay an income tax at a rate of 5.75% at the entity level for taxable years 2021 through 2025. Instead of income and the corresponding tax burden being passed down to shareholders or partners of a PTE, it will all now be at the company level.
You could be wondering about what happens with the income tax paid by individuals who own such entities. Well, there will be a corresponding refundable income tax credit for the same period for any amount of income tax paid by a qualifying PTE having Virginia taxable income and makes this election and pays the elective income tax (5.75%) imposed at the entity level. Owners of the pass-through entity can claim this refundable credit on their individual returns. This legislation aims to shift the tax burden from the PTE owners to the PTE itself.
The State of Virginia also clarified companies eligible to elect to be taxed as pass-through entities as defined below.
According to this new legislation, a qualifying PTE, in this case, is:
- 100 percent owned by natural persons or,
- In the case of a Subchapter S corporation, 100 percent owned by natural persons or other persons eligible to be shareholders in an S corporation.
Here are more details about this new PTE tax legislation in Virginia.
- The State will delay the implementation of the elective PTE tax until at least October 15, 2023, due to the announcement’s timing.
- Qualifying PTEs cannot elect nor pay this new tax at the entity level for the tax year 2022
- Owners of qualifying PTEs cannot claim this refundable tax credit for the tax year 2022
- The election (based on these new rules for Virginia) will be made retroactively for the tax year 2021. And the Virginia Tax Department will announce the required guidelines before October 15, 2023.
- Only then will a qualifying PTE be permitted to make an election and pay the entity-level tax for Taxable Year 2021 according to the then published guidelines.
- According to the guidelines, owners of the PTEs will also be allowed to claim the refundable income tax credit for the tax year 2021.
Information about PTE taxes paid to other States.
Suppose you are a resident of Virginia and own a pass-through entity in another State under the same tax structure. You may claim the refundable income tax credit right away (for the tax year 2021) on your individual return for certain taxes paid by your PTE under another State’s ‘substantially’ similar PTE tax structure. I understand that the tax season has already passed, but should you be eligible to claim this credit and didn’t, quickly book a quick tax chant with me to find out how I can help you file an amended return. My contact details are in the next paragraph.
However, there may be exceptions as to who should claim this credit, for example, in the case of franchise taxes. Contact me for further guidance if you have any more questions about the above. Call our office at (202)618-1297. We will be able to help you.
Kindly note that our office will be closed between April 20 and May 11, 2022.
Frequently Asked Questions
- What is pass-through entity tax?
This is a tax type that Sole Proprietors, LLCs, S-Corporations, and some Partnerships can elect annually. The tax avoids double taxation as it allows shareholders or members to be taxed on business income passed to them without taxing the company itself. However, the new legislation in Virginia will see to it that taxes are levied at a business level at a flat 5.75% tax rate.
- What are examples of pass-through entities?
Examples of PTEs are Sole Proprietors, LLCs, S-Corporations, and Partnerships owned by life partners, for example, a husband and a wife.
- What is the advantage of a pass-through entity?
A pass-through entity protects shareholders or partners of eligible businesses from double taxation. Double taxation is when your company pays corporate tax, and you, as the owner, also pay income tax on the money you earn from the business.
- Is LLC a pass-through entity?
Yes, an LLC is a pass-through entity.
- Is a sole proprietor a pass-through entity?
Yes, a Sole Proprietor is a pass-through entity.
