Introduction
On February 8, 1999, Governor Sundquist proposed the elimination of the Tennessee sales tax on food and a major new and unique tax structure for the taxation of businesses which operate in Tennessee. Under current law, corporations are subject to (i) a franchise tax at a rate of 25 cents on each $100 of the corporation's net capital value and (ii) an excise tax of 6% of a corporation's net income. Other forms of business enterprise are not taxed. The new business tax replaces the current corporate franchise and excise taxes with a tax on all businesses equal to 2.5% of the company's compensation paid to its employees (less $50,000)and 2.5% of the profit the company reports for federal income tax purposes (less $50,000). The proposed new tax would go into effect July 1, 1999. Corporations would pay franchise and excise taxes through June 30, 1999.
No legislation has been introduced. This memorandum is based upon the official description and materials provided by the Governor's office to the legislature.
Compensation
Compensation has not been defined. It is likely, however, that at a minimum compensation will include all items included in taxable compensation for federal income tax purposes. Consequently, compensation resulting from the exercise of non-qualified stock options will likely be taxed.
Taxable Entities
While the Tennessee franchise and excise taxes apply only to corporations, the new business tax would apply to all businesses regardless of the form in which they are conducted. Consequently, partnerships, sole proprietorships and limited liability companies ("LLCs"), as well as corporations, would be subject to the new business tax. Tax exempt organizations will be taxed on unrelated taxable business income and related compensation.
Credits
The various credits available under the excise tax, such as the industrial machinery credit, day care facility credit, and enterprise zone/new employees credit will be available as offsets against the new business tax. It is unclear, however, whether corporations who negotiated credits against the Tennessee excise/franchise taxes as part of a relocation package to Tennessee will be able to use those credits against the new business tax.
Impact of New Business Tax
The new business tax will be an incremental cost of doing business in Tennessee for (i) all partnerships, LLCs and sole proprietorships and (ii) small closely held corporations which have little net capital value, and which, as a practical matter, have no net income because profits represent compensation through salary and bonuses to the owner employees. For example, under current law, a general contractor which is operated in corporate form, which has an office with a net value of $100,000, a payroll of $300,000, excluding payments to the owner/operator, and a profit of $50,000, which is bonused as salary to the owner/operator, will pay a franchise tax of $250 and no excise tax. Under the new proposed business tax, the same business would pay a business tax of $6,250 or 12.5% of its profits. Apparently, the business tax applies to compensation even though the business does not earn a profit. So, for example, under the new business tax, a labor intensive business which does not generate a profit could have a substantial tax. If, for example, a large grocery store had salaries and wages of $1,050,000, and a net loss of $200,000, it would still owe a $25,000 business tax.
Generally, the new business tax will increase the taxes paid by service industries and decrease the tax paid by capital intensive industries. For any service sector company, which has a small net capital value and therefore pays little or no franchise tax, the new business tax will be a tax increase if that business' salary and wage expense is 140% or more of its profit. Obviously, the tax burden would shift from highly capital intensive businesses to highly labor intensive businesses and virtually assures a competitive disadvantage to Tennessee in recruiting businesses that use the knowledge and skills of highly compensated employees or which provide a large number of lower paid jobs.
Conclusion
The new business tax represents a sweeping change in Tennessee's taxation of businesses and, if passed, will have broad economic ramifications. Please let us know if you would like us to keep you apprised as details about the new business tax are released in proposed legislative form.
On February 8, 1999, Governor Sundquist proposed the elimination of the Tennessee sales tax on food and a major new and unique tax structure for the taxation of businesses which operate in Tennessee. Under current law, corporations are subject to (i) a franchise tax at a rate of 25 cents on each $100 of the corporation's net capital value and (ii) an excise tax of 6% of a corporation's net income. Other forms of business enterprise are not taxed. The new business tax replaces the current corporate franchise and excise taxes with a tax on all businesses equal to 2.5% of the company's compensation paid to its employees (less $50,000)and 2.5% of the profit the company reports for federal income tax purposes (less $50,000). The proposed new tax would go into effect July 1, 1999. Corporations would pay franchise and excise taxes through June 30, 1999.
No legislation has been introduced. This memorandum is based upon the official description and materials provided by the Governor's office to the legislature.
Compensation
Compensation has not been defined. It is likely, however, that at a minimum compensation will include all items included in taxable compensation for federal income tax purposes. Consequently, compensation resulting from the exercise of non-qualified stock options will likely be taxed.
Taxable Entities
While the Tennessee franchise and excise taxes apply only to corporations, the new business tax would apply to all businesses regardless of the form in which they are conducted. Consequently, partnerships, sole proprietorships and limited liability companies ("LLCs"), as well as corporations, would be subject to the new business tax. Tax exempt organizations will be taxed on unrelated taxable business income and related compensation.
Credits
The various credits available under the excise tax, such as the industrial machinery credit, day care facility credit, and enterprise zone/new employees credit will be available as offsets against the new business tax. It is unclear, however, whether corporations who negotiated credits against the Tennessee excise/franchise taxes as part of a relocation package to Tennessee will be able to use those credits against the new business tax.
Impact of New Business Tax
The new business tax will be an incremental cost of doing business in Tennessee for (i) all partnerships, LLCs and sole proprietorships and (ii) small closely held corporations which have little net capital value, and which, as a practical matter, have no net income because profits represent compensation through salary and bonuses to the owner employees. For example, under current law, a general contractor which is operated in corporate form, which has an office with a net value of $100,000, a payroll of $300,000, excluding payments to the owner/operator, and a profit of $50,000, which is bonused as salary to the owner/operator, will pay a franchise tax of $250 and no excise tax. Under the new proposed business tax, the same business would pay a business tax of $6,250 or 12.5% of its profits. Apparently, the business tax applies to compensation even though the business does not earn a profit. So, for example, under the new business tax, a labor intensive business which does not generate a profit could have a substantial tax. If, for example, a large grocery store had salaries and wages of $1,050,000, and a net loss of $200,000, it would still owe a $25,000 business tax.
Generally, the new business tax will increase the taxes paid by service industries and decrease the tax paid by capital intensive industries. For any service sector company, which has a small net capital value and therefore pays little or no franchise tax, the new business tax will be a tax increase if that business' salary and wage expense is 140% or more of its profit. Obviously, the tax burden would shift from highly capital intensive businesses to highly labor intensive businesses and virtually assures a competitive disadvantage to Tennessee in recruiting businesses that use the knowledge and skills of highly compensated employees or which provide a large number of lower paid jobs.
Conclusion
The new business tax represents a sweeping change in Tennessee's taxation of businesses and, if passed, will have broad economic ramifications. Please let us know if you would like us to keep you apprised as details about the new business tax are released in proposed legislative form.