Virginia PTET for Multitier Tax Partnerships: One Bridge Too Far?

Posted on by Kurt Magette

Virginia enacted retroactively a pass-through entity tax (“PTET”), which applies in 2021 through 2025, inclusively. The PTET allows certain “qualified pass-through entities” to elect to pay Virginia taxes at the legal entity level. The objective is to avoid the federal income tax limit on deduction of Virginia taxes for the owners of the entity through converting the deduction into a credit.

The Department of Taxation (“VDOTax”) sought comments to determine how to make this legislation actually function. In a July 22, 2022 blog and in a letter to the Commissioner of VDOTax, I addressed one issue: how to apply the PTET to tax partnerships that have tax partnerships as partners (“Multitier Tax Partnerships”). The common example would be an LLC operating in Virginia (the “Lower-Tier Partnership” or “LTP”), which has one or more LLCs (taxed as partnerships) as tax partners (each, an “Upper-Tier Partnership” or “UTP”).

The PTET only applies to a “qualifying pass-through entity,” which requires a tax partnership (such as our LTP) to have only tax partners (members) that are natural persons (which includes disregarded entities with natural persons as their sole member). An S corporation can be a qualifying pass-through entity if all its shareholders are natural persons or are otherwise eligible S corporation shareholders. Thus, on its face, the PTET regime would be unavailable to Multitier Tax Partnership (a tax partnership is not a natural person). My earlier blog and letter listed reasons the PTET should apply to Multitier Partnerships of which all the indirect partners are natural person or eligible to be S corporation shareholders (“Qualifying MTPs”).

On October 31, 2022, VDOTax issued “Draft Guidelines” that rejected the position that Qualifying MTPs should be allowed to elect PTET. The Draft Guidelines state that the UTP can elect PTET if it qualifies (has only tax partners (members) that are natural persons or that would be eligible S corporation shareholders). One surmises that VDOTax is unwilling to qualify my Qualifying MTPs based on a strict reading of the statute. That was the metaphorical one bridge too far. Certainly, VDOTax cannot be criticized for taking this position, but now practitioners are left waiting for legislative action that will undoubtedly not occur before the provision sunsets or its impetus to exist does (the federal deduction work-around).

Beyond this disappointment, the Draft Guidelines provide useful information (other than for 2021) including logistics and penalties. The Draft Guidelines disclose that they are not law or regulation (which, based on Virginia law, they cannot be) but that a taxpayer relying on them, even if a court finds them invalid, shall be deemed to have received “erroneous written advice” from VDOTax. That reliance standard is critical for Virginia Code Sections 58.1-1835 (abatement of tax, interest, and penalty) and 58.1-105 (offers in compromise).

Please note, this article provides an update to a July 2022 article entitled Virginia Pass-Through Entity Tax and Multiplier Tax Partnerships, where Kurt provides an overview of the PTET and the challenges it faces. You can read that article here.

About the Author

Kurt Magette is a business, commercial real estate, and tax lawyer. His practice focuses on business and commercial real estate transactions requiring significant expertise in federal and Virginia income taxes.

Spotts Fain publications are provided as an educational service and are not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.