By: Michelle Freeman, CPA, and Shelby Follis, CPA
The 2024 spring tax season proved to be more challenging than Tennessee taxpayers anticipated, with major changes not only lingering at the federal level but on the Tennessee franchise and excise tax return as well. Tennessee enforces a franchise and excise tax filed on Form FAE 170 annually. Recently, when the constitutionality of the property base used to calculate franchise tax was questioned, Tennessee lawmakers were faced with a challenging reform and remedy for taxpayers. The following article will help you and your clients understand these Tennessee franchise and excise tax changes and navigate the potential refund process.
Background on the Tennessee Franchise and Excise Tax
All entities operating in Tennessee with limited liability protection to their owners are required to file Tennessee Form FAE 170 to pay the Tennessee franchise and excise tax. The excise tax was first enacted in 1923, followed by the franchise tax in 1937. The Tennessee excise tax is calculated on the business’ net earnings apportioned to Tennessee. Schedule J is used to calculate excise tax, starting with federal taxable income with adjustments based on Tennessee tax law and finally adjusted for apportionment. The excise tax base calculated on Schedule J is then multiplied by a 6.5% excise tax rate.
For tax years ending on or before Dec. 31, 2023, the Tennessee franchise tax was calculated from the greater of the business’ net worth or the book value of real or tangible personal property owned or used in Tennessee. The net worth measure is calculated on Schedule F, where a taxpayer will list the sum of total assets less liabilities, which is then multiplied by the apportionment factor if a multi-state business. The property measure is calculated on Schedule G of Tennessee Form FAE 170, which requires a taxpayer to list out the cost less accumulated depreciation of property by type. The property measure also includes rent expense paid, which is multiplied by various factors based on property type. The greater of the net worth or property measure is then multiplied by 0.25% for the franchise tax. A minimum franchise tax of $100 is required (Tennessee Department of Revenue, 2021).
Tennessee Franchise Tax Challenged
Found unconstitutional recently by a trial court, the franchise tax property measure was alleged to be unconstitutional by failing the internal consistency test in a lawsuit filed by Toyota Motor Credit Corporation, bringing the potentially unconstitutional aspects of the franchise tax to light. Lawmakers were pressed to remedy the situation. The complaint explained the concept that if all states imposed the franchise tax using property as the base measure, then a multi-state taxpayer would have a higher cumulative state tax liability than an interstate taxpayer would. The Toyota Motor Credit Corporation’s lawsuit was not the only situation convincing Tennessee lawmakers an adjustment was necessary. Many businesses sought out representation and contacted the Tennessee Department of Revenue
for refunds, while other businesses contacted lawmakers. By repealing the property measure, Tennessee lawmakers aim to shield the state from claims the calculation violates the U.S. Constitution’s commerce clause (Mattise, 2024).
The internal consistency test is used to determine whether the law under question would hinder interstate commerce. The internal consistency test can be more simply understood when compared to littering, according to Jamie Zug in an article published by Bloomberg Tax. Essentially, it may not be disastrous for one person to litter, but if everyone littered, it would cause major issues. Therefore, it may seem acceptable for the state of Tennessee to impose a property measure franchise tax, but if all states did, it would create a significant burden on taxpayers (Zug, 2022). To avoid any further legal risk, Public Chapter 950 (2024) repealed the property measure as a factor in calculating franchise tax after being signed into law on May 10, 2024.
As previously discussed, prior to the adjustment, franchise tax was calculated using the larger of a business’ apportioned net worth or the book value of its real or tangible property owned/ rented in Tennessee. The larger of the two would then be multiplied by 0.25%, with a minimum of $100 due as franchise tax. With the repeal of the property measure, only the net worth would be considered. After a compromise was reached between the Senate and House of Representatives, the bill was finalized, allowing for refund opportunities dating back to tax filings after Jan. 1, 2021, with transparency provisions (Bologna, 2024).
The Refund Claim Process
Starting on May 15 through Nov. 30, 2024, taxpayers have a window of opportunity to apply for refunds for tax returns filed on or after Jan. 1, 2021. For example, a calendar-year taxpayer would be able to apply for a refund for tax years 2020-2023. Many resources are available to aid in the refund process, including a webpage with a recorded webinar showcasing the process, written instructions and frequently asked questions. To apply for a refund, a taxpayer must have filed the return for the year they are applying using Schedule G, which is a list of the different types of property a business may possess in Tennessee, to calculate the property measure. Then, an amended return will need to be filed excluding any amounts on Schedule G. If no amounts were included in Schedule F calculating the net worth measure, then it will need to be completed in the amended return. When considering whether to file for a refund, the tax preparer needs to take into account any tax credits listed on Schedule D and the effect this alteration may have on carryovers. It is important to note that when amending a return for the Schedule G refund, there should be no other amendments to the return, or complications could occur.
Once the amended return is filed, then the taxpayer will apply for their refund using the specific form Claim for Refund of Franchise Tax Paid on Property Measure (Schedule G). This form can be found on the main webpage https://www.tn.gov/revenue/2024franchisetax.html. It is important to note all of this can be easily accomplished through Tennessee Taxpayer Access Point (TNTAP), and the Tennessee Department of Revenue walks through this process in a recorded webinar on the main webpage referenced above. It is preferable to file these returns and claims electronically through TNTAP for a lower processing time, but they can be paper filed. No direct deposits will be set up. Instead, a check will be issued to the business’ address, which will need to be verified in TNTAP. No 1099-G will be issued for these refunds because it is a refund of franchise tax. If the refund is not processed within 90 days, interest will also be paid to the taxpayer at the federal rate.
At the end of the process, the tax preparer will need to sign off on two disclosures. The first requires acknowledgment that the taxpayer’s name and range of corresponding refund will be published to the Tennessee Department of Revenue website from May 31-June 30, 2025. The second disclosure explains that the taxpayer waives all rights in any court based on the theory that the franchise tax property measure is unconstitutional by failing the internal consistency test as previously discussed (TN.gov Services, 2024).
2024 Estimate Calculations
Looking forward to the remainder of 2024, tax preparers need to consider the implication of these changes when paying estimates. If the repealed property measure was used to calculate 2024 estimated payments, a recalculation will need to be done only using net worth. Furthermore, one is led to question the taxability of the refunds in the year they are received. Because these refunds were presumably related to taxes deducted from taxable income at the federal level, one would expect the refund to be taxable income. Franchise tax is not adjusted out of the excise tax calculation, so Tennessee taxable income may also be elevated by these refunds. There has been no further discussion on the topic of taxability from the Tennessee Department of Revenue at this time.
Consequences or Opportunities?
After careful analysis, the Fiscal Review Committee concluded the cost of the refund process would be approximately $1.55 billion, with decreases of franchise tax collections in future years of about $400 million annually. The $52.8 billion budget passed on April 25, 2024, includes a reserve specifically for Schedule G refund claims and reflects the reduction in franchise tax collections. Despite the loss of revenue, Tennessee’s Rainy Day Fund soars at a historical high of $2.15 billion, with a $100 million commitment of funds (Tennessee Office of the Governor, 2024).
Tennessee is already considered a “tax haven” for its residents based on the simple fact that it does not impose an income tax. As a counterbalance, Tennessee imposes various taxes, such as sales tax, excise taxes and franchise taxes. Business filings in Tennessee have increased significantly over the past 15 years. For example, in the first quarter of 2023, 21,516 new business filings and 199,309 annual reports were recorded, a record high since this data began to be recorded in 1998 (University of Tennessee, Knoxville: Boyd Center for Business & Economic Research, 2023). The question of whether this trend will continue to increase in the years to come sounds like a promising “yes” with the repeal of the property measure portion of the Tennessee franchise tax calculation.
To conclude, many taxpayers have already taken advantage of the refund opportunities provided by the property measure repeal. The process can be streamlined and simplified for most taxpayers by filing an amended return through TNTAP. However, if a taxpayer has any credits that may be affected by these adjustments, a more detailed calculation may be needed. All necessary resources can be found on the Tennessee Department of Revenue’s webpage dedicated to this process. If you have any questions, concerns or comments, please feel free to reach out to the columnists.
About the Authors
Shelby Follis, CPA, is a tax manager at LBMC. She can be reached at shelby.follis@lbmc.com.
Michelle Freeman, CPA, is an associate professor and coordinator of the MAcc program at East Tennessee State University. She can be reached at freemanms@mail.etsu.edu.
References
Bologna, M. J. (2024). Tennessee Lawmakers Back $1.55 Billion in Franchise Tax Refunds. Bloomberg Tax.
Mattise, J. (2024). Tennessee lawmakers split on how and why to give businesses major tax help under fear of lawsuit. AP News.
Tennessee Department of Revenue. (2021). Franchise and Excise Tax Manual.
Tennessee Office of the Governor. (2024). Gov. Lee Marks the Close of the 2024 Legislative Session. tn.gov/governor/news.
TN.gov Services. (2024). Franchise Tax Property Measure (Schedule G) Refunds. Retrieved from TN.gov: https://www. tn.gov/revenue/2024franchisetax.html
University of Tennessee, Knoxville: Boyd Center for Business & Economic Research. (2023). Business and Economic Indicators. The TN Quarterly, 1.
Zug, J. (2022). Internal Consistency Erasure and Taxpayer Protection (1). Bloomberg Tax. Retrieved from Bloomberg Tax.
This article was originally published in the July/August 2024 Tennessee CPA Journal.
