When purchasing commercial real estate, it is common, for tax and liability reasons, to form a single purpose entity to own the property. Many times, the entity that is formed is a limited liability company. Forming an LLC is generally relatively cheap, fast, and shields the members of the LLC from liability. However, when forming an LLC in Tennessee, or any other entity that provides limited liability to owners there are tax implications to consider that may not arise in other states.
Tennessee does not collect income tax from individuals on most forms of income. Instead of imposing income taxes, Tennessee imposes various other taxes, including two forms of taxes for the privilege of doing business in the state.
In Tennessee an excise tax and franchise tax are imposed on corporations, subchapter S corporations, limited liability companies, professional limited liability companies, real estate investment trusts, limited partnerships, and registered limited liability partnerships. The owner’s of all of these foregoing entities benefit from some form of limited liability and the excise tax and franchise tax essentially tax the privilege of having limited liability. Out of state corporations and LLCs are also subject to the excise and franchise taxes. General partnership and sole proprietors do not enjoy limited liability and are not subject to these taxes. The excise tax is calculated based on the net income of the LLC or corporation for each tax year. The franchise tax is based on the greater of the net worth of the LLC or corporation or the value of the real property and tangible personal property owned in Tennessee for each tax year. Generally, if a tax payer owes one of these taxes, it owes both of the taxes.
The excise tax is 6.5% of the net earnings of the corporation or LLC generated from business transaction in Tennessee for each tax year. The franchise tax is 0.25% of the greater of the corporation’s or LLC’s net worth or the value of the real property and tangible personal property owned in Tennessee for each tax year. The minimum franchise tax owed by each corporation and LLC each year us $100.00.
Purchasers of real property in Tennessee need to consider the franchise excise tax when preparing their pro forma for a development and determining what form of entity to create to own the property. The excise and franchise taxes cause some purchasers of real property in Tennessee to form general partnerships and other forms of entities that are not subject to the taxes. Many times, purchasers who form partnerships to own property in Tennessee do so because the cost of their insurance to cover expected liabilities is cheaper than the cost of paying the franchise and excise taxes. Regardless, before forming an entity, purchasers should engage a competent attorney and accountant to determine the effects of the excise and franchise taxes on the transaction.