Tennessee made essential strides in bettering its tax construction when it accomplished phaseout of the Corridor Tax—the state’s earnings tax, which was levied solely on curiosity and dividends earnings. This alteration was a few years within the works, making Tennessee the eighth state with out a person earnings tax. However whereas Tennessee now boasts no particular person earnings tax, there’s nonetheless extra work to be achieved for companies—Tennessee is in a great place to get the job achieved.
Tennessee’s normal fund income grew by 8 p.c in FY 2021 and the Division of Income expects this development to proceed in FY 2023, albeit at a slower tempo. Utilizing this recurring development to enhance the tax code would set the state up for persevering with success.
Companies in Tennessee withstand three separate layers of taxation: one thing akin to a typical company earnings tax however which additionally applies to S Companies and most LLCs (the Excise Tax), a capital inventory tax on companies’ internet price (the Franchise Tax), and a gross receipts tax (the Enterprise Tax). If the Volunteer State is trying to construct off its ahead momentum and make the state extra engaging to companies, all three of those taxes are ripe for enchancment. Sole proprietors and normal partnerships are exempt from Franchise and Excise taxes, however they apply to different pass-through companies which might sometimes be topic to particular person earnings taxes in different states. Subsequently, pass-through companies don’t take pleasure in the identical profit as they might if working in another states with out a person earnings tax.
Tennessee’s flat enterprise earnings tax charge of 6.5 p.c is in the midst of the highway when in comparison with different states. Even so, there are areas the place the Volunteer State might stand to enhance its construction—particularly, its apportionment components and therapy of capital funding.
When C firms conduct enterprise in multiple state, they need to apportion their earnings to every state wherein they’ve nexus for tax functions. At present, states can use three elements of their apportionment formulation: the share of complete property, payroll, and gross sales {that a} agency has positioned in every state. Traditionally, most states weighted these elements evenly, however there’s a pronounced development towards giving higher—and even unique—weight to the gross sales issue. Doing so usually advantages in-state corporations whereas exporting among the tax burden to corporations with gross sales, however much less of a bodily presence, within the state.
Tennessee at present has three issue apportionment, with the gross sales issue receiving double weight. It is a completely legit method to apportion company earnings, however in a panorama the place states are more and more favoring in-state operations, retaining a three-factor apportionment components might make Tennessee look much less aggressive in the long term.
Extra uncompetitive than the apportionment components is the state’s therapy of capital funding. Eighteen states enable the speedy write-off of all enterprise funding, following the federal therapy, whereas Tennessee requires companies to deduct capital bills in accordance with preset depreciation schedules. In different phrases, as a substitute of instantly deducting capital bills within the yr the funding occurred, it might take 15 years earlier than Tennessee acknowledges the total value of an funding to a agency.
This creates an issue. Because of inflation and the time worth of cash, a greenback sooner or later is all the time price lower than a greenback in the present day. Delaying deductions for the price of enterprise investments signifies that the actual worth of the deductions will all the time be lower than the unique value. In the end, this therapy means the company earnings tax is biased towards funding in capital property, as different enterprise bills (e.g., labor, promoting, and provides) will be written off within the first yr. That is particularly dangerous to companies in equipment-intensive, manufacturing industries.
It’s price mentioning that the creation of the online curiosity deduction limitation—present in part 163(j)—on the federal stage was supposed to assist pay for prices from the implementation of full expensing. Notably, whereas Tennessee doesn’t conform to the business-friendly part expensing provisions, the state does conform to the revenue-raising part 163(j).
Federal expensing provisions are set to run out in 2023; no state has acted to increase this deadline. On the similar time, the federal curiosity limitation is changing into extra stringent. This creates a chance for the Volunteer state: conforming to federal expensing provisions would deliver Tennessee again consistent with its friends, whereas making full expensing a everlasting a part of its company tax code would set the state aside.
The Franchise Tax
Tennessee is one in every of 16 states to levy a franchise (or capital inventory) tax on companies. Amongst these states, it levies the fourth-highest charge of 0.26 p.c and doesn’t place a cap on funds.
In contrast to company earnings taxes, that are levied on a enterprise’s internet earnings (or revenue), franchise taxes (or capital inventory taxes) are levied on a enterprise’s internet price. As a type of company wealth taxation, the franchise tax bears lots of the inefficient hallmarks of a person wealth tax however with extra implications for the financial system.
“Capital inventory,” which this tax targets, contains the worth of all of the bodily elements a agency makes use of to generate its items or providers, minus the agency’s debt. Franchise taxes are levied no matter whether or not a enterprise makes a revenue, making them particularly onerous to new companies which have but to show a revenue, and to all companies throughout occasions of financial downturn.
During the last 10 years, lawmakers have grown to understand the issues with franchise taxes. Because of this, 4 states have fully repealed their franchise taxes, and two extra are within the means of phasing them out.
Tennessee would do properly to comply with swimsuit in no matter method it might. Because the franchise tax makes up a good portion of the state’s enterprise revenues (the tax introduced in $1.07 billion for the state in FY 2021), a full repeal within the close to future would probably be tough. Nevertheless, lawmakers ought to pursue making a fee cap and reducing charges to scale back the state’s reliance on the franchise tax.
The Enterprise Tax
Tennessee additionally levies a low-rate gross receipts tax on all companies which have nexus within the state. Charges vary from 0.02 p.c to 0.3 p.c, relying on enterprise classifications. In contrast to company earnings taxes, which goal precise earnings, gross receipts taxes are utilized to an organization’s product sales, with out deductions for enterprise bills like compensation and value of products offered. Seven states at present levy gross receipts taxes.
Even with charges as little as these in Tennessee, gross receipts taxes may cause financial harm. Enterprise-to-business transactions usually are not exempt, so the identical financial worth is taxed throughout every transaction within the manufacturing course of. This compounds the impact of the tax, which may result in increased costs for purchasers, decrease wages for employees, or extra restricted job alternatives. Affected corporations are incentivized to vertically combine, change industries, or depart the taxing jurisdiction.
Companies and industries with decrease revenue margins or extra phases within the manufacturing course of—as every one is taxed individually—are hit more durable by gross receipts taxes than are high-margin companies which are vertically built-in. Differential charges try to regulate for these variations on an industry-by-industry foundation however achieve this imperfectly. As with franchise taxes, gross receipts taxes will be notably extreme for start-ups and entrepreneurs, who sometimes publish losses in early years whereas nonetheless owing gross receipts funds.
The state leans much less closely on this tax than the franchise tax, as gross receipts introduced in $264 million for the state in FY 2021. The native portion of the enterprise tax makes full elimination a tough dialog. Nevertheless, as Tennessee’s gross receipts charges are already comparatively low, lawmakers can work to additional scale back reliance on such an economically dangerous tax on the state stage.
Conclusion
In an period the place companies and employees are more and more cellular, state tax competitors turns into extra essential than ever earlier than. Tennessee has already taken essential steps in the fitting route, and the legislature appears to be all for persevering with this progress. If lawmakers want to make the state as aggressive as potential, they need to take this chance to enhance the state’s company tax construction and to scale back the state’s reliance on its extra economically damaging franchise and gross receipts taxes.
As they start one other legislative session, lawmakers can have a good time previous successes whereas urgent on to make the Volunteer State a extra engaging enterprise vacation spot.