Here’s what you need to know about how new federal changes will impact the Volunteer State.
Federal tax reform has rolled into Tennessee — and it will have an impact on the state itself and for businesses filing Tennessee franchise and excise tax returns.
Here are some of the ways the new and changed laws will affect Tennessee businesses and residents. For additional questions, reach out to your tax advisor at LBMC to discuss what matters to you, or keep up to date on current happenings with federal tax reform by visiting LBMC’s resource center.
Where Tennessee begins
Changes made to federal taxable income generally also mean changes to Tennessee taxable income. As a “rolling” conformity state, Tennessee automatically conforms to the latest version of the Internal Revenue Code. However, like other “rolling” conformity states, Tennessee may “decouple” from certain provisions it doesn’t wish to follow.
Federal changes Tennessee may decouple from
One-hundred-percent bonus depreciation: Federal tax reform allows for 100-percent expensing of short-lived capital investments for five years and then phases out the provision over the next five. Since Tennessee has historically decoupled from all federal provisions that have enacted bonus depreciation, it’s reasonable to conclude the state will do the same this time around.
Contributions to capital: Federal tax reform clarifies that contributions to capital do not include any contribution in aid of construction, any other contribution made by non-shareholders and any contribution made by any governmental entity or civic group. Tennessee currently conforms to the federal treatment of contributions to capital of a corporation by excluding capital contributions from gross income. The federal tax reform change includes contributions from government entities in gross income. Tennessee may decouple from this change for policy reasons instead of revenue reasons. As a matter of fact, proposed legislation has been filed to decouple Tennessee from this provision.
Related Party Interest and Intangible Expenses: Federal tax reform denies deductions for disqualified related party amounts paid or accrued to a hybrid transaction. Tennessee has its own provisions which require related party interest and intangible expenses to be added back to the tax base. Consequently, Tennessee is likely to decouple from this federal law change. If Tennessee doesn’t decouple, it may cause complexity when trying to determine how the federal limitation interacts with Tennessee’s limitations.
Dividends received deduction: Federal tax reform reduces the deduction for dividends received from other than certain small businesses or those treated as “qualifying dividends” from 70 percent to 50 percent, and dividends received from 20-percent-owned corporations from 80 percent to 65 percent. Tennessee does not conform to the federal treatment of the dividends-received deduction. However, the state permits the deduction of dividends from a corporation that is owned 80 percent or more by the taxpayer. Tennessee may decouple in this instance and maintain its current treatment.
Foreign dividends and foreign tax credit: Federal tax reform allows a deduction by a domestic corporation of dividends received from a 10-percent-owned foreign corporation and disallows a foreign tax credit for foreign taxes paid or accrued with respect to qualifying dividends. Tennessee currently does not conform to the federal treatment of foreign dividends, instead permitting a subtraction modification to federal taxable income for dividends received from a foreign corporation by a taxpayer that owns 80 percent or more of the foreign corporation’s outstanding capital stock.
In April 2018, the Tennessee Department of Revenue issued Notice #18-05 stating that Tennessee will allow a dividends-received deduction for the amount received from an 80-percent or more owned foreign corporation, to the extent the dividends income is actually included in the taxpayer’s federal taxable income.
Federal changes that have may have no impact on Tennessee franchise and excise tax
Federal Net Operating Loss (NOL) Changes: Federal tax reform eliminates net operating loss carrybacks while providing indefinite net operating loss carryforwards, limited to 80 percent of taxable income for losses arising in tax years beginning after 2017. The changes to the federal NOL have no impact on the Tennessee tax calculation. Because Tennessee NOLs are computed separately from federal NOLs, no additional modification to federal taxable income is necessary.
Federal repeal of domestic production deduction: Federal tax reform repeals the federal domestic production deduction. Tennessee has always decoupled or disallowed the domestic production deduction, so the repeal has no impact on the Tennessee tax calculation.
Twenty-percent-deduction for pass-through entities: Federal tax reform creates a new 20-percent deduction for individuals, trusts and estates to take from qualified business income from partnerships, S-corporations and sole proprietorships. According to the federal tax law, each business passes through the allocable share of income or loss to the partners or shareholders. Then the individual partner or shareholder calculates the 20-percent deduction separately for each trade or business. Tennessee does not impose an individual income tax, except on dividends and interest. Additionally, Tennessee generally does not follow the federal income tax treatment of pass-through entities and instead imposes entity-level taxes under the Tennessee Excise Tax on LLPs, LPs, LLCs, S-corporations and most LLCs. The new 20-percent deduction that decreases the tax base for federal tax purposes at the individual level is not likely to impact the tax base of a pass-through entity on Tennessee’s franchise and excise tax return.
Federal changes that may increase Tennessee franchise and excise tax
Deemed repatriation: One of the main drivers of federal tax reform was to allow businesses to bring accumulated foreign profits into the country at a lower tax rate to increase investment and jobs. Federal tax reform includes a deemed repatriation clause that taxes cash at 15.5 percent and other illiquid assets at 8 percent. Tennessee currently conforms to the federal treatment of Subpart F income and IRC Sec. 78 Gross-Up. The deemed repatriation could increase the Tennessee tax base for businesses and produce a one-time windfall for the state.
Limitation on interest deduction: Federal tax reform disallows a deduction for net interest expenses that exceed 30 percent of adjusted taxable income for business with average annual gross receipts in excess of $25 million. This limitation applies to interest paid to related and unrelated parties. Tennessee’s current provisions require related party interest and intangible expenses to be added back to the tax base. Consequently, the main impact of the federal interest expense limitation most likely would be an increase to the Tennessee tax base for interest paid to unrelated parties. The complexity will be trying to determine how the federal limitation interacts with Tennessee’s limitations.
Repeal of like-kind exchanges except for real property: Federal tax reform repeals like-kind exchanges in general, and only allows the like-kind exchange rules to continue to apply to real property that is not held primarily for sale. Tennessee currently conforms to the federal treatment of like-kind exchanges and is likely to conform to this change.
Research and experimentation expenses: Starting with costs paid or incurred after Dec. 21, 2021, federal tax reform requires domestic research expenses to be amortized over five years and foreign research expenses to be amortized over 15. Tennessee currently conforms to the federal treatment of research and experimental expenses and is likely to continue.
Federal changes that may decrease Tennessee franchise and excise tax
Section 179 expensing: Federal tax reform raises the Section 179 small business expensing cap to $1 million with a phase-out starting at $2.5 million. It also expands the definition of “qualified property” to include certain depreciable personal property used to furnish lodging and improvements to nonresidential real property (such as roofs, heating and property-protection systems). Tennessee has historically conformed to federal enhanced expensing provisions, and it is reasonable to assume the state will do the same this time.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.