The Tennessee Revenue Commissioner recently concluded that a part of that state’s franchise tax that is based on the value of property located in Tennessee (the real and tangible property base) is likely unconstitutional. Legislation has been introduced in the Tennessee legislature that, if enacted, would repeal the real and tangible property tax base component of the franchise tax. This legislation would provide taxpayers who paid the franchise tax based on the real and tangible property base with a refund opportunity.
Background of Tennessee's Franchise Tax and Excise Tax
The state of Tennessee levies an annual franchise and excise tax on all business entities doing business in the state. Unlike most states, Tennessee makes no distinctions between partnerships and corporations (C corporations or S corporations). Subject to certain exceptions, only sole proprietors and general partnerships who operate a business outside of a legal entity (e.g., a corporation, limited liability company, limited partnership, etc.) that provides liability protection can escape a filing requirement.
The tax consists of two components. The first is a franchise tax, which is based on the greater of a company’s book net worth (as apportioned to Tennessee) or a company’s book value of fixed assets and capitalized rented assets located in Tennessee. The second is a separate excise tax, which is an income-based tax on a business’s federal taxable income, as modified and then apportioned to Tennessee. The excise/income tax is not the subject of the potential refund claims.
Constitutionality of Franchise Tax in Jeopardy
As mentioned previously, the franchise tax has two bases: (a) an entity’s book net worth as apportioned to Tennessee (the net worth base); and (b) the book value and capitalized rental value of an entity’s physical property in Tennessee (the real and tangible property base). The higher of the two bases is subjected to tax.
Many believe that this “dual-base” calculation violates the internal consistency test established by the U.S. Supreme Court in 1983 (Container Corp of America v. Franchise Tax Board, 463 U.S. 159 (1983)) and more recently examined by another court in Comptroller of the Treasury of Maryland v. Wynne (135 S.Ct. 1787 (2015)).
The internal consistency test requires a supposition that every state in the U.S. imposes a tax identical to the one being considered, and to then determine whether a taxpayer engaged in interstate commerce would pay more aggregate taxes than a similarly situated taxpayer doing business in only the one state whose tax is being considered. If the tax of the interstate taxpayer is greater, then the state tax fails the test and is unconstitutional.
Because Tennessee’s franchise tax couples an apportioned net worth tax with what is basically a property tax (based on property located within the state), the interaction of the two tax bases can result in multiple taxation incidences.
Recently, North Carolina abandoned a similar taxing system that was part of its franchise tax and replaced it with an apportioned net worth base for years beginning in 2022 and all subsequent years.
Refund Mechanics
The bill would provide taxpayers with the opportunity to file refund claims within three years from Dec. 31 of the year in which payment of the tax was made. For instance, if a 2020 Tennessee franchise tax was paid in March 2021, then taxpayers would have until Dec. 31, 2024, to file a refund claim.
Refunds will be calculated based on the difference between the originally reported amount of tax under the real and tangible property base and the tax calculated using the apportioned net worth base. For instance, if the originally reported franchise tax using the “property” base was $100,000 and the tax calculated using the apportioned net worth base is $80,000, then the taxpayer will be eligible for a $20,000 refund.
Final Thoughts on the Tennessee Franchise Tax Decision
Please note that no court in Tennessee has yet decided that Tennessee’s franchise tax is unconstitutional, and the Tennessee legislature may not pass the bill providing relief to taxpayers who paid franchise tax using the property tax base. Nevertheless, companies impacted by the legislation may want to pursue protective refund claims even if the legislature does not provide relief later this year.
Many businesses that paid Tennessee franchise tax using the real and tangible property base are filing refund claims with the Tennessee Department of Revenue. Recently, the Tennessee Revenue Commissioner, after consulting with the Tennessee Attorney General, testified before the Tennessee legislature that the current tax system is in jeopardy and indicated that the state is making preparations to pay out substantial amounts of franchise tax refunds to impacted taxpayers.
If have any questions regarding these developments and refund opportunities, please contact Geoff Christian in the CBIZ National SALT practice, Jay Brower, the primary author of this article, or your local CBIZ tax professional.
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