Tennessee Estate Planning Law : Tennessee Estate Planning Lawyer & Attorney : Bryan Howard : Howard & Mobley Law Firm : Nashville, Chattanooga, Memphis

A lot of my clients recently received a Franchise and Excise Tax Annual Exemption Renewal Form from the Tennessee Department of Revenue. This form applies to Limited Liability Companies and Limited Partnerships that claim an exemption from Tennessee Franchise and Excise Taxes.

The three most common exemptions that apply to my clients are the obligated member entity (“OME”) exemption, the family-owned non-corporate entity (“FONCE”) exemption, and the farm exemption. If your company qualifies for one of these exemptions, you need to fill out the renewal form with the help of your CPA and send it to the Department of Revenue no later than April 15, 2010. If your company qualifies for an exemption and you have not received the form, you can get the form at http://tennessee.gov/revenue/forms/fae/fae183.pdf, or you can call the Department of Revenue at (615) 253-0600.

If you do not file the form by April 15, 2010, you will lose your exemption for 2009. The Department has the discretion to allow a late filing. If they allow a late filing, they will charge you a $1,000 penalty.
 

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Tennessee imposes Franchise and Excise Tax on limited partnerships and limited liability companies unless they qualify for an exemption. Due to a law change enacted earlier this year, numerous entities converted from the family owned non-corporate entity (“FONCE”) exemption to the obligated member entity (“OME”) exemption.

The OME exemption requires the entity’s owners to assume personal responsibility for liabilities of the entity. Most entities that switched to the OME exemption own commercial real estate.

In order to qualify for the OME exemption for 2009, appropriate documentation had to be filed with the Tennessee Secretary of State by October 1, 2009. On November 10, 2009, the Department of Revenue imposed an additional requirement to qualify for the OME exemption for 2009.

Each entity that switched to the OME exemption must file a new Application for Exemption with the Department of Revenue on or before November 30, 2009. If the entity does not file an Application for Exemption by November 30, 2009, it will not be exempt for 2009.

The Department of Revenue has discretion to allow a late filing of the application. However, if they permit the late filing, they must charge a $1,000 penalty.

If the entity failed to convert to an OME prior to October 1, 2009, it has the option of converting to an OME prior to December 31, 2009 if the entity wants to be exempt from franchise and excise taxes for 2010 and future years.

If you are an owner of an OME and are concerned about your potential exposure to liabilities of the entity, you should consider transferring a portion of your assets to an asset protection trust.
 

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When you own a business with one or more other persons, it is advisable to enter into a written agreement with the other owners. These agreements have different names depending upon the type of entity: shareholder agreements for corporations, partnership agreements for limited partnerships and general partnerships; and operating agreements for limited liability companies. These agreements are sometimes generically referred to as “Buy-Sell Agreements”.

Buy-Sell Agreements typically restrict transfers to third parties and specify rights of the parties under certain circumstances such as death, divorce and disability. It is not uncommon for these agreements to give the company and/or the other owners an option to buy your interest in the company for a predetermined price in the event that you die, or become disabled, or transfer your stock to any other person, including your spouse upon divorce. The price is generally less than a proportionate share of the value of the entire business.

If a divorce court awards a portion of your interest in the company to your spouse, your spouse may contend that he or she is not bound by the Buy-Sell Agreement. Alternatively, your spouse may argue that your interest in the company should be valued based upon the different method than that contained in the Buy-Sell Agreement.

Customarily, spouses do not sign Buy-Sell Agreements unless they own an interest in the company. However, a recent case decided by the Tennessee Court of Appeals provides a good reason for asking your spouse to sign the Buy-Sell Agreement.

In the Inzer (pdf) case, the wife argued that her husband’s stock in his company should not be valued in accordance with a formula contained in the Buy-Sell Agreement. The Court indicated that the wife’s argument would have been meritorious if she had not signed the Buy-Sell Agreement. Because she signed the Agreement, the Court ruled that she was bound by the valuation formula.

For purposes of valuing the couples' marital estate, the stock was valued significantly below its pro rata share of the total value of the company. Because the husband was awarded the stock, this meant that the wife received a smaller share of the other assets. As a result of this case, I plan to recommend that my clients ask their spouses to sign their Buy-Sell Agreements.
 

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Family limited partnerships (or LLCs) are often used to obtain valuation discounts for estate and gift tax purposes. Appraisers typically conclude that the fair market value of an interest in a family limited partnership (“FLP”) is at least 35% less than the value of the assets owned by the FLP.

The IRS dislikes these discounts and has successfully challenged the discounts in several court decisions. As a general rule, the taxpayers were "sloppy" in the cases that the IRS has won. Errors were made either in funding, distributions, or record keeping.

When the FLP is properly funded and administered, taxpayers are able to substantiate the discounts. For every case in which the IRS has successfully disallowed discounts, there are many others where the court approved a discount or the IRS agreed to a discount without going to trial.

A case in point is the recent Rayford L. Keller et al v. United States decision. Mrs. Williams was in the hospital, dying from cancer. Six days before her death, she signed documents to establish an FLP to be funded with $240 million of bonds and $10 million cash.

The assets were not transferred to the FLP until one year after she died. Nevertheless, the Court ruled that her family was entitled to a 47.5% discount on the value of the bonds and cash that were transferred to the FLP.

I do not recommend waiting until death is imminent to establish an FLP. It is far better to establish the FLP when you have several years to live, and then to make gifts or sales of FLP interests when that is appropriate.

Detailed summary of Keller case by Steve Akers of Bessemer Trust Company, N.A.

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Your family LLC or limited partnership might be hit with a large tax bill from the Tennessee Department of Revenue for 2009 and future years. The law was recently changed to remove the exemption from Franchise and Excise taxes for certain family LLCs and limited partnerships that own commercial real estate.

Under prior law, rent income from commercial properties was defined as passive, which allowed family-owned entities to avoid paying the tax. The new law changes the definition of passive income to exclude rental income from commercial properties and residential properties containing more than four units.

The result of this change is to make entities owning such property subject to franchise tax on the value of the entity’s property ($2,500 per million dollars of value) and an excise tax of 6.5% on the net income earned by the entity.

If the owners of the entity do not want to pay the tax, they can waive liability protection prior to October 1, 2009. This means that if the entity suffers a judgment that exceeds the value of the entity's assets, the owners would be personally liable for the judgment. A lot of my clients are choosing this option and purchasing additional liability insurance.

Another change concerns the registration requirements for all entities that claim an exemption from Tennessee Franchise and Excise taxes. Each such entity must notify the Tennessee Department of Revenue of its exemption within sixty (60) days after creation and then each following year no later than April 15. If you are late, the Department of Revenue will either eliminate your exemption or charge you a $1,000 penalty.

Questions and answers regarding franchise and excise taxes.

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