Tennessee’s 2023 Legislative Session Ends with Tax Law Changes

Tennessee has enacted several changes to its three most significant taxes (Sales and Use Tax; Franchise and Excise Taxes; and the Business Tax). House Bill 323 was passed by both houses of the Tennessee General Assembly and was signed by Governor Bill Lee on May 11, 2023, and has been assigned Public Chapter No. 377.

The tax package was first unveiled during Gov. Lee’s State of the State address on February 6, 2023, and billed as the “Tennessee Works Tax Act of 2023.” The proposal was couched as having three broad aims: improving Tennessee’s economic competitiveness; simplifying taxes for Tennessee businesses; and providing relief to Tennessee working families. Some of the more significant changes are addressed below.

Sales and Use Taxes

The legislation’s most significant component from a revenue impact perspective is a three-month state-wide sales tax holiday on food and food purchases set to begin August 1, 2023. Tennessee has had sales tax holidays in the past for certain items, but never one of this magnitude. From August 1 through October 31, 2023, sales tax will not apply to the retail purchases of food and food ingredients. Initial estimates projected this to be a $288 million tax benefit for Tennessee consumers, with the Governor’s Office estimating the benefit to be $100 per Tennessee family. It is anticipated that the Department of Revenue will issue additional guidance soon, likely in the form of an Important Notice.

In addition, the law will make several changes to Tennessee’s existing sales tax laws, primarily around how to source those sales. The legislation further clarifies the treatment of certain taxable repair, cleaning, and installation services that occur out of state. Specifically, this legislation clarifies that the repairing of tangible personal property (TPP) or computer software; the laundering or dry cleaning of TPP; the installing of TPP that remains TPP after installation; and the installing of computer software, are subject to Tennessee tax even where the repair, cleaning or installation occurs at a place of business outside Tennessee if the serviced TPP or computer software is delivered by the seller to (i) the purchaser (or its designee) within the physical limits of Tennessee, or (ii) a carrier for delivery to a place within the physical limits of Tennessee. This provision effectively changes the sourcing from where the service is actually provided (current law) to where the serviced goods are destined.

The legislation makes several other changes to Tennessee’s sales and use tax provisions. These changes are aimed generally at making Tennessee’s sales tax law more accordant with the provisions of the Streamlined Sales Tax Agreement and the 23 other states that have adopted those SSTA provisions as part of their sales tax regimes.

Franchise and Excise Taxes

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.

Business Tax

The Business Tax is Tennessee’s gross receipts tax on the sale of tangible personal property and most services to Tennessee customers. This tax has been in place since 1971 but is often overlooked by out-of-state entities selling into Tennessee. The tax applies to entities that have a location in Tennessee (i.e. physical presence) as well as out-of-state entities (since 2016) that have triggered economic nexus by exceeding a sales threshold of $500,000 annually. This legislation enacts several “taxpayer-friendly” modifications:

  • Increased threshold for filing exemption. Under current law, a business with taxable sales in excess of $10,000 is required to file an annual Business Tax return with the state and obtain a business license from the county and/or municipality in which it operates. This legislation increases the exemption threshold from the current $10,000 to a new ceiling of $100,000. The state projects that this change will relieve approximately 140,000 current Business Tax filers from having to file prospectively.
  • Expanded manufacturing exemption. Current law provides that an entity primarily engaged in manufacturing at a Tennessee location is exempt. This legislation will expand the exemption to apply to sales by entities primarily engaged in manufacturing (i.e. “fabrication and processing of tangible personal property for resale and consumption off the premises”) from any location, not just Tennessee locations. Additionally, the exemption will be expanded to apply not only to sales of products made from the manufacturing location, but also to any such sales made from a storage or warehouse facility located within a 10- mile radius of the manufacturing location.
  • Reduced Tax Rate for Industrial Loan and Thrift Companies. The Business Tax carries different rates depending on the type of item being sold and whether the sale is a retail or wholesale sale. The tax rates range from a low of 1/50 of 1% (0.0002) to a high of 3/16 of 1% (0.001875), with the sole outlier being industrial loan and thrift companies which carry a rate of 0.3. This legislation will reduce the rate for those to a more “middle of the road” rate of 1/10 of 1% (0.001).
  • Higher Licensing/Filing Threshold for Certain Contractors. Contractors are currently subject to the Business Tax and have special rules regarding where they must file and obtain licenses. Under current law, a contractor will be deemed to have established a location within a county and/or municipality (“deemed location”) when it has taxable sales exceeding $50,000 in that jurisdiction even if it does not have an actual physical location in that jurisdiction. This legislation increases that threshold to $100,000. This will simplify the licensing and filing requirements for contractors staying below those thresholds in jurisdictions where they do not have an actual location.

The TDOR has also issued the following Important Notices addressing these tax law changes. These notices are posted on the Department of Revenue’s website at Important Notices.

Content provided by LBMC State and Local Tax professional, Jay Hancock.

Jay Hancock is the LBMC State and Local Tax Practice Leader. He can be reached at 615-690-1982 or jay.hancock@lbmc.com.

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.

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