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Virginia recently enacted a series of tax bills during its latest legislative session, including legislation that advanced Virginia’s conformity with the Internal Revenue Code (IRC) to the version in effect as of Dec. 31, 2019.1
Separate legislation amended the state’s partnership audit reporting requirements to align with federal reporting requirements under the Bipartisan Budget Act of 2015 (BBA).2
Amended budget legislation instituted several administrative measures to alleviate the impact of COVID-19, including interest and penalty waivers for delayed tax payments, extended payment deadlines for individual and corporate income taxes, and interest waivers for sales tax payments.3
Finally, the state enacted a temporary electronic skill games tax to back a COVID-19 relief fund.4
Virginia advances federal conformity to Dec. 31, 2019
Virginia generally employs static conformity to the IRC. Legislation enacted on Feb. 17, 2020, advanced the state’s conformity date from Dec. 31, 2018, to Dec. 31, 2019, also conforming the state with the Further Consolidated Appropriations Act of 2020.5
While Virginia generally advanced its date of conformity, it continues to decouple from several provisions of the IRC, including bonus deprecation, net operating loss (NOL) carrybacks, cancellation of debt income, high-yield debt obligations, and limitations on itemized deductions.6
Virginia’s updated conformity impacts several Virginia tax provisions.
As a result of Virginia’s updated conformity date, there are now over 30 extender provisions that may apply to Virginia income taxpayers. These provisions include the deduction for qualified tuition, exclusion from gross income for a discharge of qualified principal residence indebtedness, as well as the treatment of qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction.7
Disaster relief provisions
Virginia’s updated conformity also incorporates several IRC provisions covering disaster relief for events that occurred in 2018 and 2019.8
These provisions include the removal of the charitable deductions cap for disaster response, a waiver of the additional 10% tax on early distributions from retirement accounts for individuals in disaster areas, modifications to the deduction for personal casualty loss, and adjustments to the way in which earned income is calculated for individuals within a disaster area.9
It should be noted that these provisions do not apply outside the 2018 or 2019 tax years.
Changes to the tax treatment of retirement plans
The updated conformity date also incorporates the adjustment to the allowable age for in-service distributions from 62 to 59½; requirements for non-spousal beneficiaries of IRAs to withdraw and pay taxes on distributions within 10 years of inheritance; as well as raising the minimum age for required minimum distributions from 70½ to 72 years old.10
Finally, the rules governing multiple employer plans and pooled employer plans are broadened to widen the scope of participation.
Although Virginia has updated its IRC conformity date, it will continue to decouple Virginia taxable income from specific provisions that the Commonwealth has designated as fixed date conformity adjustments.11
These adjustments continue to include bonus depreciation for certain assets; five-year NOL carrybacks for losses generated in a taxpayer’s 2008 and 2009 tax years; exclusions related to cancellation of debt income; deductions related to the application of the applicable high-yield debt obligation rules; and the suspension of the overall limitation on itemized deductions.12
Virginia will also decouple from the medical expense deduction under IRC Sec. 213(f)(2).13
While Sec. 213(f)(2) permits taxpayers to claim a deduction if certain medical costs exceed 7.5% of adjusted gross income through 2018, Virginia will continue to use a 10% floor. Taxpayers claiming a medical expense deduction in Virginia are required to demonstrate an additional 2.5% on top of the 7.5% of income needed to claim a deduction on their federal returns.14
Conformity with federal partnership reporting requirements
The BBA altered federal partnership reporting requirements for reporting adjustments to federal taxable income.15
Since the adoption of the BBA, Virginia had not conformed to these requirements at the state level, and partners remained responsible for reporting any federal adjustments. On April 10, 2020, legislation was enacted to align Virginia with the federal provisions and transfer the reporting burden from the partners to the partnership itself upon election, with an effective date of July 1, 2020.16
The corresponding bill establishes two distinct procedures for partnerships reporting federal adjustments, as well as outlining requirements for modified reporting agreements.
The default rule under the legislation is for the partnership to report adjustments to both the Virginia Department of Taxation and the partners.17
All partners are responsible for reporting their distributive shares of the adjustments to the Department and for payment of any tax due.18
The partnership will have 90 days after the final determination on an adjustment to file a federal adjustments report with the Department, notify the partners of their distributive share of the adjustments, file an amended composite return for non-resident partners, pay any additional withholding tax or income tax from a composite return, and file an amended pass-through entity return.19
Within one year, the partners are required to file with the Department a federal adjustments report specifying the partner’s distributive share of adjustments, and pay any additional tax due as a result of the adjustment.20
Alternative method and modified reporting agreements
Partnerships may also elect to report information about federal audits directly to the Department.21
In order to utilize this alternative method, the partnership simply needs to file an adjustment report with the state and to notify the Department of the election.22
Once this is done, the partnership will have one year to make any required payments pursuant to audit.23
For audited partnerships, an alternative method is available requiring the partnership to file an irrevocable election.24
Under this method, the partnership files a federal adjustment report identifying the partner’s distributive share of adjustments directly to the Department and submits payment for any tax due.25
This method provides the partnership 90 days following the issuance of a final federal adjustment to file an adjustment report with the Department, and to notify the Department that it will be making an elective payment.26
The partnership then has one year after the adjustment becomes final to make payment of any tax, interest, and penalty due.27
The tax rate applicable to each partner is calculated differently depending on the type of partner. Corporate or tax-exempt partners will have their distributive share multiplied by Virginia’s 6% corporate tax rate.28
Resident and nonresident partners that are individual taxpayers, trusts, and estates are taxed at Virginia’s highest individual tax rate of 5.75%.29
Pass-through entities that are partners will also have their distributive shares taxed at the highest individual tax rate of 5.75%.30
The law also allows for the Department to enter into modified reporting agreements with an audited partnership.31
However, that partnership must demonstrate that the proposed alternative method will reasonably provide for reporting and payment of the applicable tax, interest, and penalties.32
Extension of certain tax credits
The Virginia General Assembly approved legislation extending the sunset date for two significant credits. H.B. 748 extends the sunset date for R&D tax credits from Jan. 1, 2022, to Jan. 1, 2025.33
It also increases the cap on such credits, effective in the 2021 tax year, from $7 million to $7.7 million, while also increasing the aggregate cap of the major R&D expenses tax credit from $20 million to $24 million.34
This legislation extends the deadline for applying to receive related credits from July 1 to Sept. 1.35
H.B. 408 extends the sunset date for the Green Jobs Creation Credit from Jan. 1, 2021, to Jan. 1, 2025.36
This enables Virginia taxpayers to continue claiming a $500 income tax credit for each new green job created in Virginia having a salary of $50,000.37
This can be claimed for up to five years if the position is continuously filled, with a cap of 350 qualifying jobs per taxpayer.
COVID-19 related measures
Virginia has taken several tax-related measures to provide income tax payment relief to taxpayers during the COVID-19 crisis. These measures include penalty and interest waivers for delayed income tax payments, interest waivers for sales tax payments, clarification of automatic filing extensions, and the creation of a COVID-19 relief fund.
Automatic waiver of penalties and interest for state income tax
In response to the COVID-19 pandemic, the Virginia legislature approved the governor’s recommended amendments to the state’s budget technical corrections bill.38
As such, Virginia will automatically waive penalties and interest for delayed income tax filings caused by the COVID-19 pandemic. This provision protects taxpayers that submit payment by June 1, 2020. Taxpayers that do not make full payment by the June 1 deadline, but are able to pay 90% of their tax liability will not be subject to penalties, and will only be subject to interest on the portion not paid by June 1. For taxpayers that do not pay at least 90% of their liability by the June 1 due date, interest will accrue from the original due date.39
While none of these actions extend the filing deadline, Virginia provides an automatic six-month filing extension for most individual or non-profit taxpayers, and an automatic seven-month filing extension for most corporate taxpayers. These automatic extension provisions still require taxpayers to submit payment by June 1, 2020, in order for the returns to be considered filed timely, and to avoid the assessment of penalties and interest.40
Interest Waivers for Sales Tax Payments
With respect to sales and use taxes, Virginia allowed interest waivers for sales tax payments originally due on March 20, 2020.41
This wavier is only available to taxpayers with payments that are submitted to the Virginia Department of Taxation on or before April 20, 2020. This measure supplemented the Department’s previous waiver of penalties for late filing and payment upon request for tax collected during the February 2020 period and originally due by March 20.42
Creation of COVID-19 relief fund and taxation of electronic skill games
The General Assembly also approved the governor’s recommended amendments to H.B. 881, placing a tax on “electronic skill games” to finance a COVID-19 relief fund.43
This encompasses many electronic gambling devices, such as those found at bars and restaurants.44
The legislation bans such games effective July 1, 2021, and requires game distributors to pay a monthly tax of $1,200 for each game device located in Virginia from July 1, 2020, through July 1, 2021, when the devices are banned.45
The revenue from the tax will primarily finance a non-reverting relief fund to support those impacted by the COVID-19 pandemic, including small businesses, nursing homes and unemployed residents.
With the advancement of Virginia’s IRC conformity date, taxpayers have the opportunity to take advantage of several new provisions. One such opportunity is the removal of unrelated business income taxes from certain fringe benefits. Taxpayers should also be aware of Virginia’s decoupling from Sec. 213(f)(2) and the need for medical expenses to equal 10% of adjusted gross income in order to claim the medical expense deduction for Virginia income tax purposes. In advancing Virginia’s fixed conformity date, the Virginia legislature did not enact legislation that would have enabled rolling conformity with the IRC. H.B. 48 would have maintained the existing decoupled provisions, while H.B. 734 would only decouple from IRC changes resulting in a revenue impact greater than $10 million. The decision to retain static conformity may indicate the legislature’s desire to retain greater control over budgetary matters.
It should be noted that Virginia’s conformity legislation predates the enactment of the CARES Act and currently, the Commonwealth conforms to the IRC as in effect on Dec. 31, 2019. As a result, Virginia does not conform to recently enacted federal relief provisions, including IRC provisions related to qualified improvement property, extended NOL carryback provisions and the increased business interest expense limitation under section under Sec. 163(j). Further, due to Virginia’s decoupling from the CARES Act, it is currently unclear how Virginia will treat cancellation of debt income related to small business loans forgiven under the Payroll Protection Program (PPP), and the associated federal disallowance of deductions under IRS guidance.46
Pass-through entities and their owners should be aware of Virginia’s new conformity with the federal partnership audit provisions. Partners may wish to consider these provisions in drafting or amending their partnership agreements. The choice of elections by the partnership audit liabilities may have favorable or adverse consequences to specific partners depending upon whether the partner is a resident or nonresident partner, or dependent upon the pass-through entity type. Additionally, these elections may have implications to current partners related to audit exposures of partners that have exited the partnership.
In consideration of Virginia’s delayed payment deadlines and the Commonwealth’s waiver of penalties and interest for income taxes, taxpayers should be aware that even if Virginia’s automatic filing extension applies, payment is still due on or before June 1, 2020. Taxpayers unable to pay within these timeframes may consider contemporaneously documenting their difficultly filing or making payment in order to establish reasonable cause for waiver of future penalties. Finally, with respect to indirect taxes, while the Department has offered delayed payment provisions, taxpayers should exercise caution on retaining sales tax collections as corporate officers may be held individually liable for remittance duties, and in certain circumstances, be subject to corresponding criminal penalties.
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