Tennessee Franchise Tax: Everything You Need to Know
Tennessee franchise tax is an annual tax paid upon the value of an entity's assets. 3 min read
Tennessee franchise tax is an annual tax paid upon the value of an entity's assets. Many states place a separate tax, known as a privilege or franchise tax, on certain types of businesses. This is usually a tax imposed for the right to do business in a given state.
Excise and franchise taxes apply to most businesses in Tennessee, excluding sole proprietorships and general partnerships.
Calculating Franchise Tax
Franchise tax values are usually based on book value. Therefore, depreciation reduces the tax. The rate of franchise tax is 25 cents per $100 of value, so a business pays about $25 for every $10,000 worth of value.
Due to this rather low rate, the total tax for an average company that doesn't own much expensive equipment isn't high, considering that the assets are valued at cost minus depreciation. However, business owners are often surprised by the valuation of leases.
Real property and improvements are valued at book value when calculating the franchise tax, but lease value is capitalized when computing the tax. This is achieved by multiplying yearly rent by a factor of eight for real property. Other properties use other factors. Therefore, a business that pays $100,000 annually in rent has an asset that's valued at $800,000, resulting in an annual tax of $2,000.
Franchise and Excise Taxes
Business owners who have important limited liability protection are usually subject to excise and franchise taxes. In the past, only corporations had paid these taxes. In 1999, however, tax rules changed to extend these taxes to other entities, such as limited partnerships and limited liability companies.
Previously, taxpayers who did business in Tennessee were subject to excise and franchise taxes. The definition of “doing business” was any purposeful activity that one engaged in within the state for the object of advantage, benefit, or gain.
However, Tennessee adopted an amendment that placed an additional threshold before average taxpayers are subject to these taxes. Under the amendment, an entity had to both do business in the state and have substantial nexus in Tennessee.
Substantial nexus includes a direct or indirect connection between the taxpayer and the state, with the taxpayer being required to pay these taxes. Examples of what counts as substantial nexus are:
- A taxpayer who uses or owns capital in Tennessee
- A taxpayer who's organized or commercially active in Tennessee
- A taxpayer with ongoing business activity in the state and who has gross receipts that are attributable to customers
- A taxpayer who licenses intangible property to another party in Tennessee and who gets income from that use
- A taxpayer with a bright-line presence in the state
How Business Owners Approach Franchise Taxes
While franchise taxes may not be high from year to year — particularly if you compare them with the cost of federal income tax — over time, these taxes do add up. This can be a concern for businesses that have large, valuable real estate holdings. The franchise tax is an additional yearly tax levied on the value of that real property on top of the real property taxes the entities already pay.
Most business owners have their own attitudes on how they approach franchise and excise taxes, except perhaps for those businesses with significant hard assets that are unduly impacted or the few businesses with significant retained earnings year to year.
Many business owners look at excise and franchise taxes as the cost of doing business. They generally don't feel the expense is big enough to take efforts to avoid or minimize the cost of the tax. However, others use whatever means they can to minimize their tax.
Whichever approach owners take, they should avoid inadvertent actions that increase the tax, such as a failure to consider special rules.
Running your own business can be profitable and satisfying as long as you understand the various taxes and fees you'll be responsible for. While a franchise tax is often low, it can be more substantial depending on the type of business you're in. Consulting with financial and tax experts is a good way to ensure you're paying your fair share while maximizing your benefits whenever possible.
If you need help with franchise tax in Tennessee or another state, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.