2005 Tennessee Legislative Changes

Automatic Extension

New legislation creates an automatic six-month extension of time to file Tennessee individual income tax returns. The automatic extension will apply if the taxpayer attaches a written request to his or her tax return filed on or before the extended due date of the return. Taxpayers do not need to file a request for extension separate from the tax return. Taxpayers may use either an extension form from the Department of Revenue or the taxpayer's federal request for extension filed for the corresponding tax period. Interest will accrue on the unpaid amount from the original due date of the return until the tax is paid. Penalty will not apply if the return is filed and the amount due is paid on or before the extended due date and the return includes the request for extension. The effective date of this legislation is for tax periods ending on or after December 31, 2004.

College Savings Plan Exemption

College savings plans are now exempt from gift tax regardless of whether the contribution is made to a Tennessee BEST plan or an out-of-state plan. The exemption will apply to plans in existence on June 22, 2005, and to plans established after that date.

Franchise Tax Proration

Public Chapter 499 amends Tenn. Code Ann. § 67-4-2115 to allow for proration of franchise tax in two instances that were previously addressed in the department's rules:

1) if the tax year is closed within less than 12 months of incorporation, domestication or commencement of doing business in Tennessee; and

2) if the taxpayer changes its accounting period covered by the federal return (for example, the taxpayer had been reporting for federal tax purposes on a fiscal year basis and changes its accounting period to a calendar year).

No other proration of franchise tax is allowed. Consistent with existing policy, Tenn. Code Ann. § 67-4-2015 has also been amended to state that there is no proration of excise tax for a return that covers a period of less than 12 months. The effective date for this legislation is June 22, 2005.

New Deduction for Qualified Charitable Donations

Legislation was passed enacting a new deduction from net earnings for excise tax purposes equal to 75% of the amount donated to nonprofit organizations exempt form federal tax. The nonprofit organization must certify to the entity taking the deduction that the donated funds were spent on goods or serviced subject to sales and use tax. Adequate records must be maintained to support the transactions. This legislation will effect tax periods on or after July 1, 2005. The Tennessee Department of Revenue is preparing guidelines for administration of this new deduction, which should be available on the Department’s Web site by early September 2005.

Obligated Member Entity Exemption

Public Chapter 499 closes a loophole concerning limited liability entities whose members or partners elect full liability. Generally, Tennessee imposes franchise and excise taxes on all entities that provide limited liability protection to their owners. However, a limited liability company, limited partnership or limited liability partnership is exempt if all of its members or partners elect to be fully liable for the debts, obligations, and liabilities of the entity and file the appropriate documentation with the secretary of state. A number of tax planning techniques have been developed that allow limited liability entities to use this exemption while still providing limited liability protection to their owners. Therefore, the exemption has been amended. Going forward, members or partners can make the same election and create an “obligated member entity.” Such members or partners are referred to as “obligated members.” In the event that any obligated member or any owner of an obligated member (whether such ownership is in whole, in part, direct or indirect) provides limited liability protection, the obligated member entity is liable for franchise tax and excise tax on the portion of income and equity attributable to that obligated member. The new legislation is effective for tax periods ending on or after July 1, 2005.

A Taxpayer and its Affiliated Group Members May Compute Net Worth For Franchise Tax Purposes on a Consolidated Basis

For tax years beginning on or after January 1, 2004, a taxpayer that is a member of an affiliated group may elect to compute its net worth for franchise tax purposes on a consolidated basis, provided that each affiliated group member also makes such an election. Members who join the group are bound by the group’s election.

An application for computation of net worth on a consolidated basis must be submitted to the Tennessee Department of Revenue no later than the original due date of the return for the tax year. For example, a return for the calendar year 2005 is due April 15, 2006, and election to compute net worth on a consolidated basis for that year must be made no later than that date. Once made, the election remains in effect for a five-year minimum. After the initial five years, the consolidated net worth computation election will continue unless discontinued in writing by the affiliated group.

However, a transition period runs through December 31, 2006. During the transition period, the Department of Revenue will accept late elections for consolidated net worth computation or for revocation of such an election. Thus, notwithstanding the mandatory five-year period, during the transition period an affiliated group can make a one-time change in its election to compute net worth on a consolidated basis.

If an affiliated group does not elect to compute net worth on a consolidated basis, none of its members may deduct any stock or interest held in an entity doing business in Tennessee when computing their net worth franchise tax base. The statute allowing such a deduction has been repealed effective for tax years beginning on or after January 1, 2004.

Streamlined Sales and Use Tax Delay

The effective date of Tennessee’s legislation to conform to the provisions of the Streamlined Sales and Use Tax Agreement has been delayed until July 1, 2007.

Lower Threshold for Electronic Sales and Use Tax Filing

TCA § 67-1-703(b) requires taxpayers whose average monthly sales and use tax liability is $10,000 or more to make payment in readily available funds. In 2002, it became mandatory to file sales and use tax returns electronically if a taxpayer was required to pay its sales and use tax in readily available funds. Effective May 4, 2005, the requirement to file electronically and pay in readily available funds applies to any taxpayer whose average monthly tax liability exceeds $5,000. Taxpayers meeting this new threshold will be contacted by the Tennessee Department of Revenue’s Taxpayer Services Division to make arrangements for compliance with this new requirement.