November 13, 2017

Avoid Double Taxation in Tennessee

By Jennifer Yang, Manager, Tax & Business Services

Avoid Double Taxation in Tennessee State & Local Tax

Many Tennessee businesses have an interest in flow through entities subject to Tennessee taxation. The flow through income is reported by both the parent and the income producing entity. To avoid the income being taxed twice, the state allows the holding entity to exclude the flow through income or loss from its excise return. Income subject to self-employment tax is also excluded from the excise return, because Tennessee does not have an individual income tax.

Most entities doing business in Tennessee are required to file a tax return, including C and S Corporations, Limited Liability Companies (LLCs), and federally disregarded single member LLCs with non-corporate owners. General partnerships not seeking LLC protection and single member LLCs with corporate owners are not required to file separate Tennessee tax returns. The Tennessee Franchise and Excise tax has two levels:

  • 6.5% excise tax on the net earnings of the entity, and
  • $0.25 per $100 based on either the fixed asset or equity of the entity, whichever is greater.

When calculating Franchise Tax, if the holding entity owns an interest in several other entities, its equity can potentially be taxed more than once. This potential negative tax effect can be avoided for an affiliated group by making a joint election to compute net worth on a consolidated basis. To qualify for the election, all group members should have the same tax year-end, and the holding entity should directly or indirectly have more than 50% ownership interest in the affiliated member. However, each affiliated group member that is subject to the Tennessee Franchise and Excise tax is still required to file its own separate return. The only difference is that each member will calculate its franchise tax based upon its percentage owned of the consolidated net worth of all members in the group. That is assuming the assets of each group member are lower than their share of the consolidated net worth.

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A major benefit of filing franchise tax on a consolidated net worth basis is to combine members with negative capital accounts and members with positive capital accounts. The negative net worth of the first member will reduce the positive net worth of the second member. The combination will result in a lower overall tax liability for the consolidated group. Additionally, as mentioned above, if the assets of the reporting entity are higher than the apportioned consolidated net worth, the franchise tax is calculated based on the assets instead of consolidated net worth. This presents another opportunity for savings upon consolidation. If the flow through entity’s assets are greater than total net worth, the flow through entity might pay tax on the fixed assets, and the holding entity could pay tax on the investment in the flow through (positive equity). With consolidation, only the fixed assets of the flow through entity are taxed.

To compute net worth on a consolidated basis, all members of an affiliated group must file a group consolidated net worth registration form before the due date of the tax return. After the election is made, each member of the affiliated group needs to compute its net worth on a consolidated basis. First, the group needs to combine all members’ balance sheets on the last day of the year to determine net worth, which is the difference between combined assets and liabilities. Second, each member has to use three factors (property, payroll, and sales) to compute its apportionment of the group’s net worth. Finally, each member will compute its franchise tax using the calculated appointment multiplied by its percentage of the consolidated net worth.

Most taxpayers can benefit from calculating their franchise tax based on a consolidated net worth. In fact, rarely would it benefit qualifying taxpayers to file on an unconsolidated basis.

If you think you might qualify for consolidated treatment in Tennessee, or have any other questions related to Tennessee consolidated net worth filings, please contact your Marcum representative.

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State & Local Tax, Tax & Business