Tennessee’s franchise and excise (“F&E”) taxes are imposed on taxpayers doing business and having substantial nexus in Tennessee. Taxpayers are generally any entity that provides limited liability protection to its owners, e.g., corporations, LLCs, and limited partnerships. Although two separate taxes, F&E taxes are construed as one coordinate body of law and are reported on a single tax return.
The excise tax is Tennessee’s 6.5% tax on income, whereas the franchise tax is imposed on the greater of two alternative bases: (i) the taxpayer’s net worth (i.e., assets minus liabilities), or (ii) the net book value of real or tangible property the taxpayer owns or uses in Tennessee (this alternative base is frequently referred to as the “minimum measure” base). The franchise tax rate is $0.0025 ($2,500 of tax for each $1 million of tax base). Under this legislation, the first $500,000 of property will be excluded from the minimum measure base, which will provide a $1,250 franchise tax reduction to those taxpayers that pay franchise tax on the minimum measure base. Initial estimates were that this exclusion will favorably impact approximately 68,000 current F&E taxpayers. This exclusion takes effect for tax years ending on or after December 31, 2024.
The legislation enacts a similar base reduction for excise tax via a new deduction of up to $50,000, which at the 6.5% rate would create a $3,250 maximum excise tax reduction although this deduction cannot be taken where it would create or increase a net loss. The deduction will take effect for tax years ending on or after December 31, 2024.
Other F&E tax changes include:
- Recoupling to the federal bonus depreciation provisions for equipment purchased on or after January 1, 2023. Like many states, Tennessee had previously decoupled from federal bonus depreciation provisions. This bill will now permit taxpayers to deduct the cost of assets purchased on or after January 1, 2023, consistent with federal depreciation provisions. Effectively this change will accelerate the timeline in which businesses can recover the costs of investments in such capital assets.
- Increased Credit Carryforward Periods. The two primary F&E tax credits are the Jobs Tax Credits (JTC) and Industrial Machinery Credit (IMC). Generally, these credits can each be applied to offset up to 50% of a taxpayer’s combined F&E liability. Unused credits have a 15-year carryforward period. This law will increase the carryforward period to 25 years for JTC and IMC earned in tax years ending on or after December 31, 2008.
- New Paid Family Leave Tax Credit. The law enacts a new F&E credit for a two-year period (tax years ending on or after December 31, 2023 but before December 31, 2025). The credit is equal to the amount of the federal employer tax credit in IRC Section 45S (e., paid family and medical leave) as a result of compensation paid in Tennessee as determined under the payroll factor apportionment provisions. Similar to the JTC and IMC, this new credit may be applied to offset up to 50% of a taxpayer’s combined F&E liability, and unused credits will have a 25-year carryforward period.
- Transitioning to a Single Sales Factor apportionment formula. Tennessee will phase in a Single Sales Factor (SSF) apportionment formula over a three-year period. Currently Tennessee utilizes a three-factor apportionment formula that triple-weights the sales factor, i.e.,(property + payroll + [3 x sales])/5. Under a SSF approach, the property and payroll factors are dispensed with, and apportionment is calculated using only sales/receipts. Approximately 33 other states have already adopted SSF apportionment, so this change will align Tennessee with the majority of states. The switch to SSF will be phased in, with the sales factor weighting being increased as follows:
- 5X sales factor weighting, with a denominator of 7 (tax years ending on or after December 31, 2023 but before December 31, 2024);
- 11X sale factor weighting, with a denominator 13 (tax years ending on or after December 31, 2024 but before December 31, 2025); and
- Single sales factor only (tax years ending on or after December 31, 2025).
As part of this transition to SSF, the currently available apportionment elections for Tennessee manufacturers and financial asset management companies will be repealed for tax years ending on or after December 31, 2025.
- Election to remain on triple-weighted sales factor. Notwithstanding the transition to SSF, taxpayers in certain circumstances will be permitted to continue using the current 3 factor, triple-weighted sales factor apportionment formula. This new election must be made on an annual basis and will be permitted if: (1) the taxpayer has net earnings for the year rather than a net loss, and (2) the three-factor, triple-weighted sales formula results in a higher apportionment factor for the tax year. While this election will result in more income and net worth being apportioned to Tennessee than under SSF (and therefore greater tax liability), the election may be beneficial for taxpayers who would prefer to apply existing JTC and/or IMC to reduce their F&E tax liability.