For law firms based in Washington, D.C. or Maryland, a Virginia tax election could unlock substantial federal income tax savings, even if the firm has no Virginia office or presence.
Many law firms have partners who live in Virginia but work out of offices in Washington, D.C. or Maryland. While these partners generally report their share of firm income on their Virginia individual income tax returns, the firms themselves may have little reason to file a Virginia business tax return.
That decision could be costing partners a significant tax saving opportunity.
Virginia’s Pass Through Entity Tax (PTET) election provides a way for qualifying partnerships, including law firms, to pay state income taxes at the entity level. Doing so can create a federal tax deduction that otherwise may be limited at the individual partner level. The often overlooked opportunity? A law firm does not need a Virginia office or even Virginia source income to potentially benefit from this election for its Virginia resident partners.
The often overlooked opportunity? A law firm does not need a Virginia office or even Virginia source income to potentially benefit from this election for its Virginia resident partners.
Why Virginia Residency Matters More Than Office Location
Virginia generally taxes its residents on income from all sources, regardless of where that income is earned.
Under Virginia’s PTET rules, a qualifying law firm can elect to pay Virginia income tax at the entity level on the distributive share of income attributable to its Virginia resident partners, regardless of how much of that income is apportioned to Virginia.
For example, consider a law firm headquartered in Washington, D.C., with additional offices in Maryland but no physical presence in Virginia.
If several of its partners reside in Northern Virginia, the firm may be eligible to make a Virginia PTET election covering those partners’ distributive shares of income, even if the firm otherwise has no Virginia filing obligation.
For firms that have historically focused on PTET elections only in states where they maintain offices or
have nexus, this could represent an overlooked planning opportunity.
How Much Could Your Firm Save?
The potential benefits can be substantial, particularly for law firm partners with significant taxable income. Consider the following simplified example:
| Illustrative Firm Profile | Amount |
|---|---|
| Virginia resident partners | 10 |
| Annual income per partner | $1,000,000 |
| Total income attributable to VA partners | $10,000,000 |
| Virginia PTET rate | 5.75% |
| Virginia PTET paid | $575,000 |
| Assumed federal marginal tax rate | 37% |
| Illustrative federal tax savings | $212,750 |
In this example, the law firm pays $575,000 in Virginia PTET on behalf of its Virginia resident partners.
The partners generally receive corresponding refundable credits against their Virginia individual income tax liabilities, while the firm may deduct the entity level PTET payment for federal income tax purposes.
Assuming the entire payment produces an incremental federal deduction and the partners benefit at a 37% marginal federal tax rate, the result is approximately $212,750 in potential federal income tax savings, or $21,275 per Virginia resident partner.
Actual savings will depend on each partner’s individual tax situation, existing deductions, other state tax credits, and the firm’s overall tax structure. The illustration is intended to demonstrate the opportunity rather than guarantee a particular result.
Why This Opportunity May Be Overlooked
Law firms with offices exclusively in D.C. or Maryland may not routinely consider Virginia entity level tax elections.
After all, if the firm doesn’t operate in Virginia, why would it voluntarily file a Virginia tax return?
The answer lies in the distinction between where the firm conducts business and where its partners reside.
Virginia’s PTET rules specifically accommodate Virginia resident owners of pass through entities operating outside the Commonwealth. That creates a planning opportunity that may not be apparent when reviewing the firm’s state filing obligations based solely on its office locations or nexus.
Importantly, a firm’s existing PTET elections in other states, the availability of credits for taxes paid to other jurisdictions, and the allocation of tax benefits among partners should be reviewed before implementing a Virginia election.
Is Your Law Firm Missing Out?
If your firm has partners who live in Virginia but work primarily from offices in Washington, D.C., Maryland, or another state, it may be worth revisiting your PTET strategy.
Even without a Virginia office, a voluntary Virginia PTET election could produce meaningful federal tax savings.
At YHB, we work with law firms and other professional service businesses to identify state and local tax planning opportunities that can be easily overlooked. Our team can help evaluate whether a Virginia PTET election makes sense for your firm’s ownership structure and existing state tax filings.
Before assuming your firm has no reason to file in Virginia, consider whether the residency of your
partners could create an opportunity worth exploring.
