Tennessee Contemplates Sweeping $1.6 Billion Overhaul of Franchise Tax

Tennessee lawmakers are currently contemplating a $1.6 billion overhaul of the state’s franchise tax. Legislation that would change the Tennessee franchise tax base calculation and, potentially, allow taxpayers to request refunds for taxes paid going back to 2021 is supported by Governor Bill Lee (R). According to line items in Lee’s recommended budget, the cost would be $410 million in fiscal year 2025, plus an additional $1.2 billion related to refunds for the previous three years.

As many as 80 taxpayers have reportedly requested refunds, claiming that the tax, as it currently stands, violates the Dormant Commerce Clause of the U.S. Constitution. The Tennessee Department of Revenue has yet to officially comment on the growing number of refund claims.

Tennessee imposes a franchise tax, which is essentially a levy on net worth for the right to conduct business in the state, as do many other states. The tax is currently based on the greater of 1) the business’s apportioned net worth or 2) the value of its real and tangible personal property that is located in the state and used by the taxpayer. The term “property measure” is frequently used to describe the latter approach. The tax is computed at a rate of $0.25 per $100, or 0.25% of the franchise tax base.

Legal Risks in Tennessee’s Franchise Tax Structure

On January 9, Tennessee’s Revenue Commissioner David Gerregano informed lawmakers that the franchise tax’s design leaves it open to legal challenges. In particular, the property measure might be contested on the grounds that it violates the internal consistency test as articulated by the Supreme Court of the United States.

Among state franchise taxes, Tennessee’s alternative property measure is distinct. According to Gerregano, North Carolina repealed its property measure in 2022 under similar circumstances.

Gerregano testified before the Senate Finance, Ways and Means Committee, saying, “Our department and tax experts at the Attorney General’s office have identified a significant legal risk in the way the franchise tax is currently structured that could be extremely costly to Tennessee taxpayers.” He continued by saying that those same parties “have advised the administration to consider changes to the franchise tax structure.”

The Supreme Court has applied a four-part test in assessing the constitutionality of state tax regimes under the Commerce Clause. This test is considered fulfilled when a tax is applicable to an activity with substantial nexus in the taxing state, is fairly apportioned, avoids discrimination against interstate commerce, and is directly tied to the services provided by the state.

Concerns regarding the franchise tax in Tennessee emerged following the high court’s 2015 ruling in Maryland State Comptroller of the Treasury v. Wynne.

Legislation’s Relief Impact

In response to this risk, Lee is supporting HB 1893/SB2103. The proposed legislation solves the issue and provides business taxpayers with a great deal of relief. The property measure would be eliminated from the statute by the proposed law, leaving companies to base their franchise tax calculations on their apportioned net worth.

Businesses that determined their duties using the property measure in the preceding three years would be eligible for refunds under the legislation. The difference between what was paid utilizing the property measure and what would have been paid using the apportioned net worth basis would be used to compute refunds. The proposed law also establishes a refund claims procedure that will be managed by the Revenue Department. Any tax credits that were utilized to reduce franchise tax would be reinstated but would not be paid as a refund.

Smith + Howard: Experienced Tax Advisors

For business owners located in or doing business in Tennessee, a tax advisor with the knowledge, skills and experience to navigate these laws and build an effective tax strategy is crucial.

At Smith + Howard, we’re proud to serve as tax advisors to business owners across the nation. Our team of experienced tax professionals brings a sophisticated approach to tax planning that combines business and personal tax strategies to build an optimal path forward for businesses and their owners. 

To learn more about Smith + Howard’s tax services, contact an advisor today.