Does federal ERISA law shield a Tennessee S corporation from franchise and excise tax just because the company is wholly owned by an employee stock ownership plan (ESOP)?

Plain-English summary

The taxpayer is a Tennessee S corporation that is wholly owned by an Employee Stock Ownership Plan (ESOP) — a retirement plan (a trust plus a plan, intended to qualify under IRC § 401(a)) that holds 100% of the company's stock for the benefit of its employees. Because an ESOP is an ERISA-governed employee benefit plan, the company asked whether ERISA preempts (overrides) Tennessee's franchise and excise (F&E) taxes on the corporation. The Department ruled no — ERISA does not preempt Tennessee F&E tax on the S corporation.

Tennessee F&E falls on the corporation, at the entity level. Tennessee imposes a 6.5% excise tax on the net earnings of persons doing business in the state and a franchise tax on their net worth, and "persons" expressly includes S corporations. Each taxpayer files on a separate-entity basis, and — importantly — Tennessee does not recognize federal S-corporation pass-through treatment for F&E. So even though the company passes its income through to its owner for federal income tax, Tennessee taxes the corporation's own earnings and net worth. The tax applies unless an exemption or exclusion does, and the company argued ERISA is that exclusion.

ERISA only preempts state laws that "relate to" a benefit plan. ERISA's preemption clause (29 U.S.C. § 1144(a)) supersedes state laws that "relate to" an employee benefit plan — meaning laws with a "connection with or reference to" such a plan, or specifically designed to affect them. But courts start from a presumption against preemption, especially for areas of traditional state concern like taxation.

Generally applicable taxes that just raise a plan's costs aren't preempted. The Department walked through the modern case law. The U.S. Supreme Court in Rutledge v. Pharmaceutical Care Management Ass'n (2020) confirmed that a state law that merely increases plan costs or has an indirect economic effect is not preempted. That follows a long line — De Buono (a gross-receipts tax on ERISA-fund-operated medical centers), Firestone Tire & Rubber v. Neusser and Thiokol Corp. v. Roberts (Sixth Circuit, neutral generally applicable taxes) — all holding that a tax of general application is not preempted just because it has some economic impact on a plan. (A tax aimed directly at gains from selling plan assets can be preempted — Morgan Guaranty — but that's not this.)

Why Tennessee F&E survives. Tennessee's F&E taxes aren't designed to affect employee benefit plans; they apply to all persons doing business in the state and are a traditional exercise of state taxing authority. They don't apply to the ESOP, the trust, the plan, or the employee-beneficiaries — they apply to the S corporation. The only connection to the ESOP is that taxing the company leaves less money to flow to the ESOP that owns it. That's a peripheral effect, not a "relate to," so ERISA doesn't preempt. The Department noted this conclusion supersedes its older Letter Ruling 95-02, which had reached the opposite result on different (now-outdated) authority.

What this means for you

ESOP-owned and employee-owned companies operating in Tennessee

Being owned by an ESOP — even 100% — does not exempt your operating company from Tennessee franchise and excise tax. The tax is on the corporation's earnings and net worth, and ERISA doesn't shield it. Budget for F&E the same as any other Tennessee business entity.

S corporations generally — no pass-through for Tennessee F&E

Tennessee doesn't follow the federal S-corporation pass-through for franchise and excise purposes. Your S corp computes its Tennessee net earnings without regard to the S election and pays F&E at the entity level, regardless of how income is taxed federally.

When might a state law actually be ERISA-preempted?

Preemption is narrow for generally applicable taxes. A neutral tax that applies to everyone and merely raises a plan's costs survives; a law specifically targeting benefit plans, or a tax imposed directly on plan assets or plan-asset gains, is where preemption arguments have traction. A general business tax like Tennessee F&E isn't that.

Accountants and tax professionals

The excise tax is § 67-4-2007(a) (6.5% of net earnings); the franchise tax is § 67-4-2105(a) (net worth); S corporations are "persons" under § 67-4-2004(38); separate-entity filing is §§ 67-4-2106(c) and -2007(d); and S corps compute net earnings without regard to the S election under § 67-4-2006(a)(2). The ERISA preemption clause is 29 U.S.C. § 1144(a); "employee pension benefit plan" is 29 U.S.C. § 1002(2)(A). Key cases: Rutledge v. Pharm. Care Mgmt. Ass'n, 141 S. Ct. 474 (2020); De Buono v. NYSA-ILA Medical & Clinical Services Fund, 117 S. Ct. 1747 (1997); Firestone Tire & Rubber Co. v. Neusser, 810 F.2d 550 (6th Cir.); Thiokol Corp. v. Roberts, 76 F.3d 751 (6th Cir.); contrast Morgan Guaranty Trust Co. v. Tax Appeals Tribunal, 587 N.Y.S.2d 252 (N.Y. Ct. App. 1992). This ruling supersedes Letter Ruling 95-02 (Jan. 19, 1995).

Common questions

Q: My company is 100% owned by an ESOP. Do we still owe Tennessee franchise and excise tax?
A: Yes. Under this ruling, ERISA does not preempt Tennessee F&E tax on the operating S corporation. The tax is on the company's earnings and net worth, not on the ESOP or its participants.

Q: We're an S corporation. Doesn't our income pass through, so the company owes no Tennessee tax?
A: Not for franchise and excise tax. Tennessee doesn't recognize S-corporation pass-through for F&E; the corporation computes its net earnings without regard to the S election and pays F&E at the entity level.

Q: Doesn't ERISA preempt state taxes that affect a retirement plan?
A: Only state laws that "relate to" a plan — those with a real connection to or reference to it. A generally applicable tax that merely increases a plan's costs, or only indirectly affects it, isn't preempted (Rutledge, De Buono, Firestone, Thiokol).

Q: Didn't Tennessee once rule the other way?
A: Yes — Letter Ruling 95-02 (1995) found ERISA preempted tax on a corporation owned by an ERISA entity, relying on older New York authority. This 2021 ruling supersedes it, consistent with the modern Supreme Court and Sixth Circuit case law.

Q: Can I rely on this ruling?
A: Not directly. A Tennessee letter ruling binds the Department only as to the taxpayer and exact facts it addressed and cannot be relied on by anyone else. Confirm your own facts with a tax professional.

Citations and references

Tennessee statutes:
- Tenn. Code Ann. § 67-4-2007(a) (6.5% excise tax on the net earnings of persons doing business in Tennessee)
- Tenn. Code Ann. § 67-4-2105(a) (franchise tax on net worth); § 67-4-2106(a)
- Tenn. Code Ann. § 67-4-2004(38) ("person" subject to F&E includes S corporations)
- Tenn. Code Ann. §§ 67-4-2106(c), 67-4-2007(d) (separate-entity filing)
- Tenn. Code Ann. § 67-4-2006(a)(2) (S corporations compute net earnings without regard to the S election)

Federal law:
- 29 U.S.C. § 1144(a) (ERISA preemption of state laws that "relate to" an employee benefit plan); 29 U.S.C. § 1003(a)(1); 29 U.S.C. § 1002(2)(A) (definition of "employee pension benefit plan")

Cases:
- Rutledge v. Pharmaceutical Care Management Ass'n, 141 S. Ct. 474 (2020); De Buono v. NYSA-ILA Medical & Clinical Services Fund, 117 S. Ct. 1747 (1997); Firestone Tire & Rubber Co. v. Neusser, 810 F.2d 550 (6th Cir.); Thiokol Corp. v. Roberts, 76 F.3d 751 (6th Cir.); Shaw v. Delta Air Lines, Inc., 463 U.S. 85 (1983); contrast Morgan Guaranty Trust Co. v. Tax Appeals Tribunal, 587 N.Y.S.2d 252 (N.Y. Ct. App. 1992)

Superseded prior ruling:
- Tenn. Dep't of Revenue Letter Ruling 95-02 (Jan. 19, 1995) (found ERISA preemption on now-outdated authority)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/21-09fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 21-09
Letter rulings are binding on the Department only with respect to the individual taxpayer being
addressed in the ruling. This ruling is based on the particular facts and circumstances presented and
is an interpretation of the law at a specific point in time. The law may have changed since this ruling
was issued, possibly rendering it obsolete. The presentation of this ruling in a redacted form is
provided solely for informational purposes and is not intended as a statement of Departmental
policy. Taxpayers should consult with a tax professional before relying on any aspect of this ruling.
SUBJECT
The applicability of the Tennessee franchise and excise taxes to an S corporation that is owned by an
Employee Stock Ownership Trust organized as an employee benefit plan within the meaning of ERISA.
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a specific set of existing
facts furnished to the Department by the taxpayer. The rulings herein are binding upon the Department and
are applicable only to the individual taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation or
modification shall be effective retroactively unless the following conditions are met, in which case the
revocation shall be prospective only:
(A)

The taxpayer must not have misstated or omitted material facts involved in the
transaction;

(B)

Facts that develop later must not be materially different from the facts upon which the
ruling was based;

(C)

The applicable law must not have been changed or amended;

(D)

The ruling must have been issued originally with respect to a prospective or proposed
transaction; and

(E)

The taxpayer directly involved must have acted in good faith in relying upon the ruling;
and a retroactive revocation of the ruling must inure to the taxpayer’s detriment.
FACTS

[TAXPAYER] (the “Taxpayer”) is an S corporation incorporated under the laws of the State of Tennessee. The
Taxpayer established the [TAXPAYER] Employee Stock Ownership Trust (the “Trust”) effective [DATE], as a
trust under the laws of the State of Tennessee pursuant to and as part of the [NAME] Employee Stock
Ownership Plan (the “Plan”), which was executed on [DATE]. The Plan and the Trust together comprise the
employee stock ownership plan (“ESOP”). As of [DATE], the ESOP is the sole shareholder of the Taxpayer.

1

The ESOP was established to allow eligible employees to accumulate capital for their retirement. The Plan is
designed and intended to be qualified under section 401(a) of the Internal Revenue Code of 1986, as
amended, and to be funded through the Trust.
RULING
Does the Employee Retirement Income Security Act of 1974 (“ERISA”), Pub. L. 93-406, preempt Tennessee
franchise and excise taxation of the Taxpayer that is wholly owned by an ESOP that qualifies as an employee
pension benefit plan under 29 U.S.C. § 1144(a)(a)(1)?
Ruling: No. ERISA does not preempt Tennessee franchise and excise taxation of the Taxpayer.
ANALYSIS
Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons doing business within
Tennessee. 1 Tennessee also imposes a franchise tax at the rate of $0.25 per $100, or major fraction thereof,
on the net worth of a person doing business in Tennessee. 2 “Persons” subject to Tennessee franchise and
excise taxes includes, but is not limited to S corporations. 3 With certain limited exceptions, each taxpayer is
considered a separate entity and must file its Tennessee franchise and excise tax returns on a separate
entity basis. 4 Corporations that elect S corporation status calculate their net earnings in Tennessee without
regard to the S election. 5
Accordingly, Tennessee franchise and excise taxes apply to the Taxpayer as an S corporation doing business
in Tennessee unless an exemption or exclusion from taxation applies. As explained below, ERISA does not
preempt the application of franchise and excise taxation to the Taxpayer.
The ESOP is covered by ERISA. 6 Subject to certain limited exceptions that do not apply here, 29 U.S.C.
§ 1003(a)(1) extends the protections afforded by ERISA to “employee benefit plans.” There are three types of
plans: employee welfare benefit plans, employee pension benefit plans, and plans that are both of the
foregoing. 7 Under 29 U.S.C. § 1002(2)(A), an “employee pension benefit plan” is any plan, fund, or program
that provides retirement income to employees. The ESOP fits within this definition because it was formed
to provide retirement income to employees. Therefore, the ESOP is an employee benefit plan that falls under
ERISA protection.
The relevant part of the ERISA preemption provision is stated at 29 U.S.C. § 1144(a), “the provisions of this
subchapter and subchapter III shall supersede any and all State laws insofar as they may now or hereafter
1

TENN. CODE ANN. § 67-4-2007(a) (Supp. 2020).

2

TENN. CODE ANN. §§ 67-4-2105(a) (Supp. 2020) and -2106(a) (2013).

3

TENN. CODE ANN. § 67-4-2004(38) (Supp. 2020).

4

TENN. CODE ANN. §§ 67-4-2106(c) and -2007(d).

5

TENN. CODE ANN. § 67-4-2006(a)(2) (Supp. 2020).

An ESOP is an IRC § 401(a) qualified defined contribution plan. An ESOP must be designed to invest primarily in qualifying employer
securities as defined under IRC § 4975(e)(8) and meet other Internal Revenue Code requirements. ERISA was created to provide
federally mandated minimum standards for employee benefit plans. See 29 U.S.C. § 1001(a).
6

7

29 U.S.C. § 1002(3).

2

relate to an employee benefit plan…” A law relates to an employee benefit plan if it has a connection with or
reference to such a plan. 8 Thus, state laws that are specifically designed to affect employee benefit plans
are preempted by ERISA. 9 However, when reviewing a claim of preemption, the U.S. Supreme Court begins
with the presumption that Congress did not intend to preempt state laws, particularly in areas of traditional
state concern. 10
ERISA preemption is a highly litigated area that has evolved significantly in the years since the Department
first issued a letter ruling on whether Tennessee’s franchise and excise taxes are preempted by ERISA. 11 As
an example, the recent decision of the United States Supreme Court in Rutledge v. Pharm. Care Mgmt. Ass’n,
141 S. Ct. 474 (2020), reinforced a line of cases that hold that a state law that merely increases plan costs or
has an indirect economic influence on a plan is not preempted by ERISA. Rutledge makes clear that
Tennessee’s franchise and excise taxes—state laws of general application that merely increase plan costs—
are not preempted.
The line of cases upholding state tax statutes of general applicability includes the U.S. Supreme Court’s ruling
in De Buono v. NYSA-ILA Medical and Clinical Services Fund, in which the Court held that a state law imposing a
gross receipts tax on income of medical centers operated by ERISA funds was not preempted by ERISA. 12
Similarly in Firestone Tire & Rubber Co. v. Neusser, the Sixth Circuit Court of Appeals held that a neutral income
tax of general application which applies to employees without regard to their status as ERISA participants is
not preempted by ERISA. 13 Finally, in Thiokol Corp. v. Roberts, the Sixth Circuit Court of Appeals held that a
state value added tax that precluded employers from deducting compensation paid to an employee benefit
plan was not preempted by ERISA. 14 The mere fact that a statute has some economic impact on an ERISA
plan does not invalidate the statute. 15

Self-Insurance Institute of America, Inc. v. Snyder, 827 F.3d 549, 554 (6th Cir. 2016) (citing Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 96-97
(1983)).

8

9

Mackey v. Lanier Collection Agency & Serv., 486 U.S. 825, 829 (1988).

10

N.Y. State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514 U.S. 645, 656 (1995).

Letter Ruling 95-02 (January 19, 1995) stated that, under the particular facts presented, ERISA preempted taxation of a corporate
subsidiary owned by an ERISA-covered entity. The analysis relied exclusively on the New York court case Morgan Guaranty Trust Co. v.
Tax Appeals Tribunal of the New York State Dept. of Taxation and Finance, 587 N.Y.S.2d 252 (N.Y. Ct. App. 1992).
11

12

De Buono v. NYSA-ILA Medical and Clinical Services Fund, 117 S. Ct. 1747, 1749 (1997).

See Firestone, 810 F.2d 550 at 556 (considering three factors: whether the tax constituted a traditional exercise of state authority;
whether it affected relations among the principal ERISA entities - the employer, the plan, the plan fiduciaries, and the beneficiaries - or
relations between one of these entities and an outside party; and whether it had any more than a tenuous, peripheral effect on a
covered plan).
13

See Thiokol, 76 F.3d 751 (utilizing the same factors in Firestone and finding that the tax falls within an area of traditional state concern,
does not affect relations among the principal ERISA entities, and only has a peripheral effect on an ERISA plan).

14

Rebaldo v. Cuomo, 749 F.2d 133, 139 (2d Cir. 1984) (stating that “if ERISA is held to invalidate every State action that may increase the
cost of operating employee benefit plans, those plans will be permitted a charmed existence that never was contemplated by
Congress.”); cf. Morgan Guaranty Trust Co. of New York v. Tax Appeals Tribunal of New York State Dept. of Taxation and Finance, 587 N.Y.
S.2d 252, 257 (Ct. App. 1992) (stating that a tax applied directly on gains derived from the sale of plan assets is preempted by ERISA
because it is not a “cost of doing business” law.); but see Sharp v. Caterpillar, 932 S.W. 2d 230, 238-39 (Tex. Ct. App. 1996) (stating that
the “cost of doing business” distinction in Morgan Guaranty meant that Morgan Guaranty was not persuasive authority when determining
if ERISA preempts provisions of a franchise tax law because the provision is a part of a generally applicable tax scheme that only
incidentally raises the cost of doing business for some ERISA plans).

15

3

Tennessee franchise and excise tax laws are not designed to affect employee benefit plans; instead, they
are generally applicable to all persons doing business within Tennessee. Additionally, the franchise and
excise tax laws constitute a traditional exercise of state authority.
The connection that Tennessee franchise and excise tax laws have to the Taxpayer’s ESOP is that they
increase the cost of doing business for the S corporation in which the ESOP is a shareholder. These laws do
not apply to the ESOP itself or to the beneficiaries of the ESOP, nor do they apply to the Trust or the Plan.
Although the Taxpayer elected federal pass through status to eliminate its federal tax liability, Tennessee
does not recognize passthrough status for franchise and excise tax purposes. Therefore, the Tennessee
excise tax is imposed on the S corporation’s earnings rather than on the ESOP. Similarly, the Tennessee
franchise tax applies to the S corporation’s net worth rather than to the value of the ESOP.
In sum, the Tennessee franchise and excise taxes do not apply to the ESOP; they apply to the S corporation
doing business in Tennessee. Although taxing the S corporation’s earnings and net worth may result in less
money flowing from the S corporation to the ESOP, this is only a peripheral effect. As such, these taxes do
not “relate to” the ESOP within the meaning of ERISA. Accordingly, ERISA does not preempt Tennessee
franchise and excise taxation of the Taxpayer.

APPROVED:

David Gerregano
Commissioner of Revenue

DATE:

9/22/2021

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