Can an LLC that absorbs a corporation in a tax-free A reorganization, and elects to be taxed as a corporation federally, still qualify for Tennessee's obligated-member-entity exemption from franchise and excise tax — and does that exemption shield a later asset sale's gain from Tennessee excise tax?

Subject

Whether an LLC formed through an A reorganization and taxed as a corporation federally can claim the obligated member entity franchise and excise tax exemption.

Plain-English summary

The Tennessee Department of Revenue answered six related questions about a corporate restructuring: two individual shareholders merged their existing Tennessee corporation ("Oldco") into a newly formed Tennessee LLC ("Newco"), structured as a tax-free "A reorganization" under federal law, with Newco electing to be taxed as a corporation for federal purposes and later amending its articles so members are personally liable for all its debts like general partners.

The merger and the federal corporate election don't block Tennessee's obligated-member-entity exemption. Tennessee exempts an "obligated member entity" (an LLC, LP, or LLP where every member/partner is personally liable for the entity's debts, with the right paperwork filed) from franchise and excise tax. Nothing in Tennessee law disqualifies an entity from this exemption just because it arrived at its current form through a federal reorganization, and — importantly — the exemption's statutory definition specifically lists "limited liability company" without regard to how that LLC is classified for federal income tax purposes. So even though Newco elected corporate tax treatment federally (which would normally make Tennessee follow that classification for other purposes), the obligated-member-entity exemption's plain language still covers it as an LLC, as long as it meets the personal-liability and filing requirements.

The federal reorganization's tax-free treatment carries over to Tennessee, but only to the extent it's federally tax-free. Both entities are treated as corporations for Tennessee purposes (matching their federal classification), and any gain or loss from the A reorganization flows into Tennessee net earnings only to the extent it's actually recognized and included in federal taxable income — Tennessee doesn't independently recognize or block nonrecognition; it just follows the federal number. A wrinkle: if the distributing corporation must recognize gain on appreciated property it distributes as part of the reorganization (under IRC § 361(c)(2)), that gain flows into Tennessee net earnings too, since it's part of federal taxable income.

A later asset sale's gain is taxable regardless of the exemption. Even though Newco otherwise qualifies for the exemption for 2008, Tennessee separately taxes gain from selling assets if the seller qualified for the obligated-member-entity exemption at any point in the 12 months before the sale — so the sale doesn't escape Tennessee excise tax just because the entity was exempt when it happened. The timing of that gain follows federal recognition timing (the tax year the gain actually hits federal taxable income), not the contract date or closing date. None of these conclusions change if either Oldco or Newco had elected federal S corporation status — Tennessee ignores the S election and calculates net earnings as if the entity were a regular C corporation either way.

What this means for you

Business owners restructuring through mergers or reorganizations

Converting a corporation into an LLC through a federal tax-free reorganization doesn't automatically cost you Tennessee's obligated-member-entity exemption, even if the LLC elects corporate tax treatment federally — the exemption tracks entity type (LLC/LP/LLP) with personal-liability provisions, not federal tax classification. But be careful with any planned asset sale: if the entity was exempt at any point in the prior 12 months, gain from selling its assets is still taxed by Tennessee, so timing an asset sale doesn't let you dodge excise tax on the gain just by being in exempt status.

Accountants and tax professionals

This ruling untangles several overlapping rules: the "obligated member entity" definition's insensitivity to federal classification (a rare case where Tennessee's default federal-conformity rule under Tenn. Code Ann. §§ 67-4-2007(d)/67-4-2106(c) is overridden by more specific statutory language, per the plain-meaning canon from Eastman Chemical Co. v. Johnson), the federal-recognition-tracking rule for reorganization gain/loss, the 12-month lookback on asset-sale gain under § 67-4-2007(f)(1)(C), and the S-election-disregarded rule under § 67-4-2006(a)(2). Useful as a checklist when a client restructures a closely-held business and wants to preserve or verify obligated-member-entity status.

Common questions

Q: Does merging a corporation into an LLC through a tax-free reorganization disqualify the LLC from Tennessee's obligated member entity exemption?
A: No, not by itself — as long as the resulting LLC otherwise satisfies the personal-liability and filing requirements under Tenn. Code Ann. § 67-4-2008(b)-(d).

Q: Does electing to be taxed as a corporation for federal income tax purposes disqualify an LLC from this exemption?
A: No. The exemption's statutory definition specifically names "limited liability company" without regard to federal tax classification, so a federal corporate election doesn't override that plain language.

Q: If an entity is exempt as an obligated member entity, is gain from selling its assets also exempt?
A: No. Tennessee separately taxes asset-sale gain if the entity qualified for the exemption at any time in the 12 months before the sale — the exemption doesn't shield that gain.

Q: Does the timing of a sale contract versus closing affect which year the gain is taxed?
A: No. The gain is included in Tennessee net earnings in the same tax year it's recognized and included in federal taxable income, regardless of contract or closing dates.

Q: Does S corporation status change any of these answers?
A: No. Tennessee disregards the federal S election and computes net earnings as if the entity were a C corporation either way.

Q: Does this ruling bind the Department for other similar restructurings?
A: No. This is a Revenue Ruling — advisory only and not binding on the Department, even for the taxpayer who requested it.

Citations and references

Statutes and cases:

• Tenn. Code Ann. § 67-4-2008(a)(9) (obligated member entity excise tax exemption)
• Tenn. Code Ann. § 67-4-2004(28) (definition of "obligated member entity": LLC, LP, or LLP with full member/partner liability)
• Tenn. Code Ann. § 67-4-2008(b)-(d) (documentation and personal-liability requirements)
• Tenn. Code Ann. § 67-4-2105(a) (franchise tax exemption follows excise exemption)
• Tenn. Code Ann. §§ 67-4-2007(d), 67-4-2106(c) (entity classification generally follows federal tax classification)
• Tenn. Code Ann. § 67-4-2006(a)(1)-(2) (net earnings definition; S election disregarded)
• Tenn. Code Ann. § 67-4-2007(f)(1)(C) (excise tax on asset-sale gain within 12 months of exemption)
• 26 U.S.C. § 368(a)(1)(A) ("A reorganization"); § 361(a), (c)(2) (nonrecognition; gain on distributed appreciated property)
• Eastman Chemical Co. v. Johnson, 151 S.W.3d 503 (Tenn. 2004) (plain, unambiguous statutory language applied without forced limitation)

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/08-20fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 08-20
WARNING
Revenue rulings are not binding on the Department. This presentation of the ruling in a
redacted form is information only. Rulings are made in response to particular facts
presented and are not intended necessarily as statements of Departmental policy.
SUBJECT
Whether the Tennessee franchise and excise tax obligated member entity exemption is available
to a limited liability company that is the surviving entity in a tax-free A reorganization and that
elects to be treated as a corporation for federal income tax purposes.
SCOPE
Revenue Rulings are statements regarding the substantive application of law and statements of
procedure that affect the rights and duties of taxpayers and other members of the public. Revenue
Rulings are advisory in nature and are not binding on the Department.
FACTS
Oldco Corporation is a Tennessee corporation doing business in Tennessee. Oldco Corporation
has two individual shareholders, and is classified as a corporation for federal income tax
purposes. In December 2007, the two shareholders of Oldco Corporation form a new Tennessee
limited liability company (“Newco LLC”) by making nominal contributions of $100 each.
Newco LLC elects to be classified as a corporation for federal income tax purposes in
accordance with Treas. Reg. § 301.7701-2(b)(2). Both Oldco Corporation and Newco LLC have
a calendar year end to their taxable years.
In December 2007, Oldco Corporation merges out of existence and into Newco LLC, in
accordance with Tenn. Code Ann. § 48-21-102. For federal income tax purposes, the merger will
be treated as a tax-free reorganization pursuant to Section 368(a)(1)(A) of the Internal Revenue
Code of 1986, as amended (an “A Reorganization”). The result of the transaction is that the
entity operating the business changes from a C corporation to a Tennessee limited liability
company that is classified as a corporation for federal income tax purposes. Effective January 1,
2008, the individual members of Newco LLC amend and sign Newco LLC’s articles of
organization to provide that each member will be personally liable for all of Newco LLC’s debts,
obligations and liabilities to the same extent as a general partner in a general partnership.

QUESTIONS

1. Assuming that effective January 1, 2008, Newco LLC otherwise meets the requirements set
   forth in Tenn. Code Ann. § 67-4-2008(a)(9) to be an obligated member entity exempt for
   purposes of Tennessee franchise and excise taxation, does the merger of Oldco Corporation
   into Newco LLC preclude Newco LLC from qualifying for the exemption under Tenn. Code
   Ann. § 67-4-2008(a)(9) with respect to the taxable year 2008?
2. Assuming that effective January 1, 2008, Newco LLC otherwise meets the requirements set
   forth in Tenn. Code Ann. § 67-4-2008(a)(9) to be an obligated member entity exempt for
   purposes of Tennessee franchise and excise taxation, does Newco LLC’s election to be
   classified as a corporation for federal income tax purposes preclude its qualifying for the
   exemption with respect to the taxable year 2008?
3. If the transfer of assets and liabilities from Oldco Corporation to Newco LLC is tax-free for
   purposes of federal income taxation as an A Reorganization, will the transfer also be treated
   as tax-free for Tennessee excise tax purposes?
4. If the assets of the business are sold in 2008, resulting in gain for federal income tax
   purposes, will such gain be subject to Tennessee excise taxation?
5. Would it make any difference if Newco LLC entered into a contract for the sale of the assets
   in December 2007, but actually closed on the sale in January 2008?
6. Would the answers to Questions 1-4 above be different if both Oldco Corporation and Newco
   LLC were taxed as S corporations for federal income tax purposes?
   RULINGS
7. No. The merger of Oldco Corporation into Newco LLC as part of an A reorganization in and
   of itself does not preclude Newco LLC from qualifying for the exemption under Tenn. Code
   Ann. § 67-4-2008(a)(9) (2007) with respect to the taxable year 2008.
8. No. Assuming that Newco LLC otherwise meets the requirements set forth in Tenn. Code
   Ann. § 67-4-2008(a)(9) (2007), Newco LLC’s election to be classified as a corporation for
   federal income tax purposes does not preclude its qualifying for the exemption as an
   obligated member entity.
9. A taxpayer that is a party to an A reorganization and that realizes gain or loss from the
   transaction will include such gain or loss in its Tennessee net earnings or loss only to the
   extent that such gain or loss is recognized and included in its federal taxable income or loss.
10. Yes. Gain from the sale of Newco LLC’s assets in 2008 will be subject to Tennessee excise
    taxation, even if Newco LLC meets the requirements set forth in Tenn. Code Ann. § 67-42008(a)(9) (2007) with respect to the taxable year 2008.
11. The date of the contract and the closing of the sale have no direct bearing on the inclusion of
    gain from the sale of the assets in Newco LLC’s Tennessee net earnings. Rather, Newco LLC

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must include the gain from the sale of its assets in its Tennessee net earnings in the same
taxable year in which such gain is recognized and included in its federal taxable income.

6. The answers to Questions 1-4 above would not change if Oldco Corporation and Newco LLC
   were taxed as S corporations.
   ANALYSIS
   Tennessee imposes an excise tax at the rate of 6.5 percent on the net earnings of certain
   “persons” doing business within Tennessee. Tenn. Code Ann. § 67-4-2007(a) (2006). Tennessee
   also imposes a franchise tax at the rate $0.25 per $100, or major fraction thereof, on a taxpayer’s
   net worth. Tenn. Code Ann. § 67-4-2106(a) (2007). Persons subject to the franchise and excise
   taxes include, but are not limited to, limited liability companies and corporations. Tenn. Code
   Ann. § 67-4-2004(30) (2007).
   Tenn. Code Ann. § 67-4-2008(a)(9) (2007) exempts from the Tennessee excise tax an “obligated
   member entity,” provided that the documentation set forth in Tenn. Code Ann. § 67-4-2008(b)(d) (2007) is filed on or before the first day of the taxable year for which a return is filed.1 Tenn.
   Code Ann. § 67-4-2105(a) (2007) provides an exemption from the Tennessee franchise tax for
   any entity exempt from the excise tax under the provisions of Tenn. Code Ann. § 67-4-2008.
   Tenn. Code Ann. § 67-4-2004(28) (2007) defines an “obligated member entity” as “a limited
   liability company, limited partnership or limited liability partnership, all of whose members or
   partners are fully liable for the debts, obligations and liabilities of the entity, as provided in § 674-2008(b)-(d), and that have filed appropriate documentation to that effect with the secretary of
   state.” A limited liability company that wishes to claim exemption from the Tennessee franchise
   and excise taxes as an obligated member entity must satisfy the specific requirements set forth in
   Tenn. Code Ann. § 67-4-2008(d) (2007). Tenn. Code Ann. § 67-4-2008(d) requires that one or
   more members of the limited liability company be identified in the company’s articles of
   organization (or amended articles) as being personally liable for all of the debts, obligations and
   liabilities of the limited liability company to the same extent as a general partner in a general
   partnership.
   1.

The merger and Newco LLC’s ability to qualify for the exemption.

The merger of Oldco Corporation into Newco LLC as part of an A Reorganization in and of
itself does not preclude Newco LLC from qualifying for the obligated member entity exemption
under Tenn. Code Ann. § 67-4-2008(a)(9) with respect to the taxable year 2008. The Tennessee
franchise and excise tax laws contain no provision that would prevent a party to a plan of

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Note that an obligated member entity may also be partially exempt from the Tennessee franchise and excise taxes.
Tenn. Code Ann. § 67-4-2008(a)(9)(D) (2007) provides that, to the extent that any obligated member, or any owner
of an obligated member, provides limited liability protection, the obligated member entity shall owe franchise and
excise taxes on the portion of its income and equity that is attributable to such obligated member.

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reorganization described in IRC § 368(a) from qualifying for the exemption under Tenn. Code
Ann. § 67-4-2008(a)(9), if the entity otherwise satisfies the statutory requirements.
2.

Newco LLC’s classification as a corporation and the obligated member entity exemption.

Assuming that Newco LLC otherwise meets the requirements set forth in Tenn. Code Ann. § 674-2008(a)(9), Newco LLC’s election to be classified as a corporation for federal income tax
purposes does not preclude its qualifying for exemption as an obligated member entity.
As noted above, Tenn. Code Ann. §§ 67-4-2008(a)(9) and 67-4-2105(a) provide an exemption
from the Tennessee franchise and excise taxes for an “obligated member entity,” which is
defined under Tenn. Code Ann. § 67-4-2004(28) as a “limited liability company, limited
partnership or limited liability partnership, all of whose members or partners are fully liable for
the debts, obligations and liabilities of the entity,” as provided in Tenn. Code Ann. § 67-42008(b)-(d).2
Newco LLC is a limited liability company that has elected to be classified as a corporation for
federal income tax purposes. Tenn. Code Ann. §§ 67-4-2007(d) and 67-4-2106(c) provide that,
for purposes of Tennessee franchise and excise taxation, a business entity “shall be classified as a
corporation, partnership, or other type of business entity, consistent with the way the entity is
classified for federal income tax purposes.” At first glance, it therefore might appear that Newco
LLC will be considered a corporation for purposes of determining whether it comes within the
exemption for obligated member entities under Tenn. Code Ann. § 67-4-2008(a)(9). As a
corporation, Newco LLC would not be entitled to claim the exemption, because it would not
come within the definition of an “obligated member entity” under Tenn. Code Ann. § 67-42004(28).
However, the language of the definition of “obligated member entity” under Tenn. Code Ann.
§ 67-4-2004(28) is clear and unambiguous. As noted above, an obligated member entity is
defined as a “limited liability company, limited partnership or limited liability partnership” that
satisfies the requirements of Tenn. Code Ann. § 67-4-2008(a)(9). The Tennessee Supreme Court
has stated that when the statutory language is clear and unambiguous, “we must apply its plain
meaning in its normal and accepted use, without a forced interpretation that would limit or
expand the statute’s application.” Eastman Chemical Co. v. Johnson, 151 S.W.3d 503, 507
(Tenn. 2004). Here, the legislature chose to use the specific terms “limited liability company,
limited partnership or limited liability partnership” in the definition of an “obligated member
entity,” without additional limiting language. To read the relevant statutory provisions as
exempting, for example, only limited liability companies that are classified as partnerships or
sole proprietorships for federal income tax purposes would impermissibly limit the statute’s
application.

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A limited liability company that wishes to claim exemption from the Tennessee franchise and excise taxes as an
obligated member entity must satisfy the specific requirements set forth in Tenn. Code Ann. § 67-4-2008(d).
Limited partnerships must satisfy the requirements set forth in Tenn. Code Ann. § 67-4-2008(b); limited liability
partnerships must satisfy the requirements set forth in Tenn. Code Ann. § 67-4-2008(c).

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Newco LLC is a limited liability company, and therefore comes within the definition of an
“obligated member entity.” Assuming that Newco LLC otherwise meets the requirements set
forth in Tenn. Code Ann. § 67-4-2008(a)(9), Newco LLC’s election to be classified as a
corporation for federal income tax purposes will not preclude its qualifying for exemption as an
obligated member entity.
3.

Treatment of the reorganization as tax-free for Tennessee excise tax purposes.

A taxpayer that is a party to an A reorganization and that realizes gain or loss with respect to the
transaction will include such gain or loss in its Tennessee net earnings or loss only to the extent
that such gain or loss is recognized and included in its federal taxable income.
The Tennessee franchise and excise tax laws neither recognize nor disallow the nonrecognition
of gain or loss to a corporation under IRC § 361(a) with respect to a reorganization described in
IRC § 368(a)(1)(A) (i.e., an A Reorganization). Rather, each taxpayer must calculate its
individual Tennessee tax liability in accordance with the applicable franchise and excise tax
provisions. Oldco Corporation and Newco LLC are classified as corporations for federal income
tax purposes. Tenn. Code Ann. §§ 67-4-2007(d) and 67-4-2106(c) provide that, for purposes of
Tennessee franchise and excise taxation, a business entity shall be classified as a corporation,
partnership, or other type of business entity, consistent with the way the entity is classified for
federal income tax purposes.
Oldco Corporation and Newco LLC are taxed as corporations for federal income tax purposes.
They must therefore determine their Tennessee net earnings or loss in accordance with the
provisions applicable to corporations. Tenn. Code Ann. § 67-4-2006(a)(1) defines “net earnings”
or “net loss” of a corporation as “federal taxable income or loss before the operating loss
deduction and special deductions provided for in 26 U.S.C. §§ 241-247 and 249” as adjusted by
Tenn. Code Ann. § 67-4-2006(b) and (c). Subsections (b) and (c) require specific addition and
subtraction adjustments to a taxpayer’s net earnings or loss to arrive at its Tennessee taxable
income; none of these adjustments applies to gain or loss realized in pursuance of a plan of
reorganization described in IRC § 368(a). Thus, Oldco Corporation and Newco LLC will include
in Tennessee net earnings or loss any gain or loss from the A Reorganization that is recognized
and included in federal taxable income or loss. If gain or loss that is realized as a result of the A
Reorganization is not recognized and included in federal taxable income or loss, the gain or loss
will not be included in Tennessee net earnings or loss.
Note that a corporation that is a party to a tax-free reorganization may recognize gain under IRC
§ 361(c)(2), which provides that a corporation that distributes certain appreciated property as part
of a plan of reorganization must recognize gain as if such property were sold to the distributee at
its fair market value. Because the distributing corporation must include such gain in its federal
taxable income, the gain would also be included in the distributing corporation’s Tennessee net
earnings or loss for the same taxable year.
4.

Inclusion in net earnings or loss of gain from the sale of Newco LLC’s assets.

Assuming that Newco LLC meets the requirements set forth in Tenn. Code Ann. § 67-42008(a)(9), Newco LLC will be exempt for purposes of Tennessee excise taxation with respect

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to the taxable year 2008. However, gain from the sale of Newco LLC’s assets in 2008 will
nevertheless be subject to Tennessee excise taxation.
Tenn. Code Ann. § 67-4-2007(f)(1)(C) (2007) provides that an entity not otherwise subject to the
excise tax must pay excise tax on the gain from the sale of any asset, if the entity “qualified for
the exemption provided in § 67-4-2008(a)(9) during the twelve-month period immediately prior
to the sale.”
The Taxpayer has indicated that the individual members of Newco LLC will amend and sign
Newco LLC’s articles of organization effective January 1, 2008, to provide that each member
will be personally liable for all of Newco LLC’s debts, obligations and liabilities to the same
extent as a general partner in a general partnership. The Taxpayer has also indicated that the sale
of Newco LLC’s assets will take place during the taxable year 2008. Because Newco LLC will
have qualified for the obligated member entity exemption under Tenn. Code Ann. § 67-42008(a)(9) during the twelve-month period prior to the sale of the assets, the sale of Newco
LLC’s assets will be subject to Tennessee excise taxation.
5.

Timing of recognition of gain from the sale of Newco LLC’s assets.

The date of the contract and the closing of the sale of Newco LLC’s assets have no direct bearing
on the inclusion of gain from the sale of the assets in Newco LLC’s Tennessee net earnings.
Rather, Newco LLC must include the gain from the sale of its assets in its Tennessee net
earnings in the same taxable year in which such gain is recognized and included in Newco LLC’s
federal taxable income.
As noted above, Newco LLC must determine its Tennessee net earnings or loss in accordance
with the provisions applicable to corporations. Tenn. Code Ann. § 67-4-2006(a)(1) defines “net
earnings” or “net loss” of a corporation as “federal taxable income or loss before the operating
loss deduction and special deductions provided for in 26 U.S.C. §§ 241-247 and 249” as adjusted
by Tenn. Code Ann. § 67-4-2006(b) and (c). Subsections (b) and (c) require specific addition and
subtraction adjustments to a taxpayer’s net earnings or loss to arrive at its Tennessee taxable
income; none of these adjustments require the inclusion of gain in Tennessee net earnings in a
year other than the year in which such gain is recognized and included in federal taxable income.
Accordingly, Newco LLC will include the gain from the sale of its assets in its Tennessee net
earnings in the same taxable year in which such gain is recognized and included in Newco LLC’s
federal taxable income.
6.

S Corporation status.

The answers to Questions 1-4 above would not change if Oldco Corporation and Newco LLC
elected S corporation status under IRC § 1362(a).
For purposes of determining Tennessee net earnings or loss, the federal S corporation election is
disregarded. As noted above, Tennessee imposes an excise tax on the “net earnings” of certain
persons, including corporations, doing business within Tennessee. Tenn. Code Ann. §§ 67-42007(a) and 67-4-2004(30). Tenn. Code Ann. § 67-4-2006(a)(2) (2007) states that, in the case of
a corporation electing S corporation status for federal income tax purposes under 26 U.S.C.
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§§ 1361-1363, “net earnings” means “federal taxable income calculated as if the corporation had
not elected S status.” If a taxpayer that is classified as a corporation had not elected federal S
corporation status, it would have calculated its federal taxable income as though it were a C
corporation. Accordingly, it makes no difference for the purposes of Questions 1-4 above
whether Oldco Corporation and Newco LLC have elected S corporation status for federal income
tax purposes.

Kristin Husat
Senior Tax Counsel

APPROVED:

Reagan Farr
Commissioner of Revenue

DATE:

3/6/08

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