State and Local Tax Alert: Tennessee Edition

Tennessee Governor Bill Haslam recently signed into law the “Improving Manufacturing, Public Roads and Opportunities for a Vibrant Economy (IMPROVE) Act” or the “2017 Tax Cut Act” (the “Improve Act”). The Improve Act is described as providing the largest tax cuts in Tennessee history, and contains some of the most significant modifications to Tennessee tax law since the 2015 Revenue Modernization Act.

KEY CHANGES OF THE IMPROVE ACT

The key changes implemented by the Improve Act include:

  • reducing taxes for qualified manufacturers by allowing them to use a single receipts factor apportionment formula for franchise and excise taxes;
  • permitting the largest localities to adopt a “transit surcharge” on top of a number of taxes;
  • reducing sales tax on retail sale of certain groceries from 5 percent to 4 percent;
  • increasing gas and diesel fuel taxes to fund a backlog of road and bridge projects (Tennessee’s first fuel tax increase since the 1980s); and
  • continuing to reduce and makes automatic the phase-out of the Hall income tax.

1. Tax Cut for Manufacturers by Allowing Single Receipts Factor Apportionment

Under current law, a taxpayer doing business in Tennessee is required to apportion its net income and net worth for purposes of the excise and franchise taxes, respectively, according to a three-factor (receipts, property and payroll) apportionment formula in which the receipts factor is triple-weighted. Under the Improve Act, retroactively applied for tax years beginning on or after January 1, 2017, a taxpayer whose “principal business in Tennessee is manufacturing” may elect to apportion its net income based on a single receipts factor apportionment formula. The key provisions are:

Principal business in Tennessee is manufacturing - More than 50 percent of the revenue derived from the taxpayer’s activities in Tennessee, excluding “passive income,” is from fabricating or processing tangible personal property for resale and consumption off the premises.

Passive income - Dividend income, interest income, income derived from the sale of securities, and income derived from the licensing or sale of patents, trademarks, tradenames, copyrights, know-how, or other intellectual property.

A taxpayer must elect this special formula on its franchise and excise tax return for the first taxable year to which the election applies. Once timely made, the election will remain in effect for the longer of five years or until it is revoked by the taxpayer.

2. Local Option Transit Surcharge for the Largest Cities and Counties

The Improve Act authorizes a handful of the largest cities and counties in Tennessee to adopt a “surcharge,” which is a “tax, or combination of taxes . . . ,” to apply on top of a number of local taxes as early as October 1, 2017. The taxes to which the surcharge may apply and the maximum tax rates for which the surcharge may be levied are:

Surcharge

Maximum Tax Rate

Local option sales and use tax surcharge

100% of current tax rate

Tourist accommodation tax surcharge

20%, when combined with underlying tourist accommodation taxes or fees, occupancy taxes, local tourism development zone business taxes, state and local option sales and use taxes, or any surcharges on the foregoing

Business tax surcharge

20% of current tax rate

Local rental car tax surcharge

20% of current tax rate

Residential development tax surcharge

20% of current tax rate

Motor vehicle tax surcharge

$200, when combined with motor vehicle tax

Note that any surcharge on the local option sales and use tax cannot apply to the following items: (1) water sold to or used by manufacturers and taxed at the 1 percent state rate; (2) sales of tangible personal property to a common carrier for use outside the state; (3) video programming services; (4) telecommunication services; (5) specified digital products; and (6) sales of tangible personal property obtained from a vending machine and taxed at the local rate of 2.25 percent. Importantly, any surcharge on the local option sales tax will also not apply to sales by dealers subject to the sales tax with no location in the state that have elected to pay the flat local tax rate.

3. Reduced Sales Tax on Certain Grocery Items

Sales tax on the retail sale of food and food ingredients for human consumption is reduced from 5 percent to 4 percent of the sales price. Consistent with the provisions of the prior statute, items not included in this tax reduction are the retail sale of food and food ingredients sold as prepared food, alcoholic beverages, candy, dietary supplements and tobacco.

4. Increased Gasoline and Diesel Fuel Taxes

The Improve Act increases gasoline and diesel fuel taxes over a three-year period, which is the first time Tennessee has passed afuel tax increase in approximately 30 years. The tax increase will fund a backlog of road and bridge transportation projects across the state (over 950 of which are specifically named in the Act). The gasoline tax will first be increased from 20 cents pergallon to 24 cents per gallon, effective July 1, 2017; then to 25 cents per gallon effective July 1, 2018; and finally to 26 cents per gallon effective July 1, 2019. Likewise, the diesel tax will first be increased from 17 cents per gallon to 21 cents pergallon, effective July 1, 2017; then to 24 cents per gallon effective July 1, 2018; and finally to 27 cents per gallon effective July 1, 2019. The current 17 cents per gallon tax rate applicable to dyed diesel fuel remains unchanged at 17 cents per gallon.

5. Continued Phase-Out of Hall Income Tax

In conjunction with last year’s 1 percent decrease in the historical 6 percent tax rate for Tennessee’s personal income tax on dividends and interest (the “Hall” income tax), the legislature confirmed its intention to continue to reduce the tax until it is ultimately phased-out, but did not make any future reductions automatic. Under the Improve Act, however, the legislature made the remaining annual 1 percent reductions automatic (to 4 percent in 2017; 3 percent in 2018; 2 percent in 2019; 1 percent in2020; and 0 percent in 2021), so that the tax will be fully phased-out for tax years beginning on or after January 1, 2021.

OTHER CHANGES

The Improve Act also increasesthe excise taxes on liquefied gas and compressed natural gas, incorporates an additional $100 registration fee on electric vehicles, and provides property tax relief for certain elderly and low-income persons, disabled persons, and disabled veterans.