On May 11, Tennessee enacted H.B. 323, the Tennessee Works Tax Act of 2023, which makes changes to franchise and excise taxes, sales and use taxes, and the business tax. This alert summarizes the most significant provisions and includes links to several notices issued by the Tennessee Department of Revenue (Department) explaining the legislative changes.
Franchise and Excise Taxes
The Works Tax Act makes numerous changes to Tennessee’s franchise and excise taxes that are imposed on corporations, including S corporations, limited partnerships, and limited liability companies taxed as partnerships for federal purposes. The most important changes involve:
- Perhaps the most significant change enacted by H.B. 323 is the phased-in adoption of a standard single sales factor (SSF) apportionment formula. Most Tennessee taxpayers that are not financial institutions apportion net earnings or loss for excise tax purposes and net worth for franchise tax purposes using a traditional ratio based on three factors (property, payroll, and sales) with a triple-weighted sales factor. The Works Tax Act adopts SSF, which will be phased in over three years by increasing the weighting of the sales factor. For tax years ending on or after December 31, 2023, the sales factor is weighted five times; for tax years ending on or after December 31, 2024, the sales factor is weighted 11 times; and for tax years ending on or after December 31, 2025, the SSF will be fully phased in.
The legislation also repeals the SSF apportionment election available to manufacturers effective for tax years ending on or after December 31, 2025. It provides an annual elective apportionment formula using three factors with triple-weighted sales for tax years ending on or after December 31, 2023. The election may be made only if the three-factor formula results in a higher apportionment ratio for the taxpayer and the taxpayer has net earnings rather than a net loss.
- Federal Bonus Depreciation. For assets purchased on or after January 1, 2023, Tennessee will now conform to the federal bonus depreciation provisions in the Tax Cuts and Jobs Act of 2017.
- Standard Excise Tax Deduction. For tax years ending on or after December 31, 2024, H.B. 323 creates a $50,000 standard deduction to reduce net earnings, but not below zero, when calculating the Tennessee excise tax.
- Franchise Tax Base Property Measure. For tax years ending on or after December 31, 2024, H.B. 323 creates an exclusion of up to $500,000 of a taxpayer’s aggregate property value from the real and tangible property measure of the franchise tax base. The $500,000 exclusion does not apply to the net worth tax base measure.
- Tax Credit Carryforward Periods. Tennessee offers various statutory tax credits to new and expanding businesses in some industries (manufacturing, call centers, research and development, etc.) if the business creates new jobs and/or purchases qualifying assets used in the state. The Works Tax Act extends the carryforward period for excess credits from 15 years to 25 years.
- Paid Family and Medical Leave Credit. The bill enacts a new tax credit based on the federal paid family and medical leave credit. Taxpayers may claim the credit for tax years ending on or after December 31, 2023, but before December 31, 2025.
Sales and Use Taxes
For businesses, H.B. 323 makes several changes to Tennessee’s sales and use tax laws. The following take effect July 1, 2024:
- Taxation of the repair of tangible personal property (TPP) or computer software, installing TPP that remains TPP after installation, and installing computer software when (1) the repair or installation occurs outside Tennessee and (2) the seller delivers the serviced TPP or computer software to the purchaser or purchaser’s designee in Tennessee or to a carrier for delivery in Tennessee for use or consumption in the state.
- Repeal of the exemption for magazines and books that are distributed and sold to consumers by U.S. mail or common carrier.
- Repeal of the exemption on the sale or use of direct mail advertising materials.
- Clarification of rules for sourcing some taxable retail products, including sales of TPP and digital goods and services.
The Tennessee business tax is a gross receipts tax on sales of TPP and most services delivered to customers in Tennessee. H.B. 323 makes several changes to benefit smaller businesses and some industries, including:
- Increased Filing Threshold. For tax years ending on or after December 31, 2023, the filing threshold for taxable sales in any individual county or incorporated municipality is increased from $10,000 to $100,000.
- Manufacturing Exemption. Under current Department policy, manufacturers are exempt from the business tax only if sales are made from the same facility where manufacturing occurs. Effective immediately, the location requirement is removed. The Department now considers the cumulative activity in the state to determine whether a taxpayer qualifies for the manufacturing exemption. Further, the exemption is expanded to include sales made from a storage or warehouse facility located within a 10-mile radius of the manufacturing location.
- The Works Tax Act’s phased-in adoption of SSF follows a trend among more than 30 states to apportion income using the SSF method for corporate income tax purposes.
- Taxpayers with material tax credits created over the past 15 years should consider the impact of the extended carryforward period for credit use in conjunction with Tennessee’s adoption of SSF apportionment. Depending on the facts and circumstances, the law changes might also affect balance sheet items (e.g., deferred tax assets). The annual three-factor apportionment formula election should also be evaluated for taxpayers in this position.
- The increase in the Tennessee business tax threshold should benefit out-of-state taxpayers, many of whom are often surprised that such a tax exists in Tennessee. The Works Tax Act’s clarification of the manufacturing exemption should benefit in-state manufacturers.
Written by Scott Smith, Kristen Weeks and Michael Person. Copyright © 2023 BDO USA, LLP. All rights reserved. www.bdo.com