When a Tennessee county assesses property tax on oil-and-gas mineral interests by looking at the income those minerals produced, is that a backdoor income tax or severance tax?

Plain-English summary

Two related questions came to the AG. First, when an assessor values mineral interests using the income approach (computing what the property is worth based on the income it produces), is that an income tax on something other than stocks and bonds (and so improper because Tennessee at the time taxed income only on stocks and bonds under the Hall income tax)? Second, does valuing minerals by reference to the income and the amount of minerals removed create an additional severance tax on oil and gas production in violation of Tenn. Code Ann. § 60-1-301?

The AG said no to both.

On the first, the goal of ad valorem appraisal is to determine the property's value to a willing buyer and willing seller. There are three traditional appraisal methods: market (comparable sales), cost (reproduction cost less depreciation), and income (present worth of expected net income over the property's economic life). The income approach is standard for income-producing property, and Tennessee's prior AG opinions and case law (Spring Hill, L.P. v. State Board of Equalization) confirm its appropriateness. Using income data to value property does not turn the resulting tax into an income tax. The opinion cites First American National Bank of Knoxville v. Olsen (Tennessee Supreme Court holding that an excise tax measured by net earnings is not converted into an income tax) and Kankakee County Board of Review (Illinois Supreme Court drawing the same distinction). The opinion also analogizes to Corn v. Fort, where the Tennessee Supreme Court held that a privilege/franchise tax is not converted into a property tax merely because it is measured by the value of property. The basic nature of the tax does not change based on which inputs the assessor uses.

On the second, the same reasoning answers the severance-tax question. Considering income (including production volumes) when valuing a mineral interest is appraisal methodology, not a separate per-unit tax on extracted minerals. So § 60-1-301's structure on oil and gas severance taxes is not displaced.

The opinion's bottom line: more productive mineral resources generate more income, which means greater value, which means a higher property tax assessment. Using the income approach to capture that economic reality is appropriate ad valorem valuation, not a hidden second tax.

Currency note

This opinion was issued in 2014. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Common questions

Q: What's the difference between an income tax and using the income approach to value property?
A: An income tax taxes a person's income directly: the income is the tax base. Using the income approach to value property uses income as evidence of value, then taxes a percentage of that value. The taxpayer who has higher-income property pays more in property tax, but the tax is still on the property's value, not on the income itself. The Tennessee Supreme Court's reasoning in Olsen and the Illinois Supreme Court in Kankakee both draw that line.

Q: What is a severance tax?
A: A tax on the act of extracting (severing) a natural resource. Tennessee imposes severance taxes on oil and gas under Tenn. Code Ann. § 60-1-301. The AG concludes the income approach does not impose a second, parallel severance tax because the property tax falls on the value of the mineral interest as an asset, not on each unit of mineral extracted.

Q: Does the assessor have to use only the income approach for minerals?
A: No. Standard appraisal practice uses all three approaches when feasible and correlates them. The opinion is about whether the income approach is permissible, not whether it is required.

Q: Can mineral-interest owners challenge the assessment?
A: Yes, through normal property-tax appeal channels (informal review with the assessor, then the county and state boards of equalization). The opinion does not change the appeal mechanics. The Spring Hill case it cites was decided in that very procedural posture.

Background and statutory framework

Tennessee property is assessed and taxed under Title 67, Chapter 5. Real property is appraised at fair market value, with assessment ratios applied by classification. The State Division of Property Assessments and the State Board of Equalization administer the system. Three traditional appraisal methods are recognized, with the income approach particularly suited to income-generating property such as commercial real estate, hotels, leased agricultural land, and mineral interests. Mineral rights can be severed from surface rights and separately taxed; valuation reflects expected production and price.

The opinion's analytical move is to keep two concepts cleanly separated: the basis on which a tax is measured versus the legal nature of the tax. Olsen and Corn are the two Tennessee Supreme Court decisions that anchor that distinction.

Citations and references

Statutes:

• Tenn. Code Ann. § 60-1-301 (oil and gas severance tax)

Cases:

• Spring Hill, L.P. v. State Bd. of Equalization, No. M2001-02683-COA-R3-CV, 2003 WL 23099679 (Tenn. Ct. App. Dec. 31, 2003) (Tennessee Court of Appeals; income approach for income-producing real property)
• First Am. Nat'l Bank of Knoxville v. Olsen, 751 S.W.2d 417 (Tenn. 1987) (Tennessee Supreme Court; excise tax measured by net earnings is not an income tax)
• Kankakee County Bd. of Review, 544 N.E.2d 762 (Ill. 1989) (Illinois Supreme Court; distinguishes income tax from income approach to ad valorem valuation)
• Corn v. Fort, 170 Tenn. 377, 95 S.W.2d 620 (Tenn. 1936) (Tennessee Supreme Court; privilege tax not converted to property tax by being measured by property value)

Earlier AG opinions cited:

• Tenn. Att'y Gen. Op. 79-509 (Dec. 4, 1979)
• Tenn. Att'y Gen. Op. 79-44 (Feb. 1, 1979)
• Tenn. Att'y Gen. Op. 77-41 (Feb. 18, 1977)

Subject

Opinion No. 14-103, Taxation of Mineral Interests, December 2, 2014

Source

• Landing page: https://www.tn.gov/attorneygeneral/opinions.html
• Original PDF: https://www.tn.gov/content/dam/tn/attorneygeneral/documents/ops/2014/op14-103.pdf

Original opinion text

STATE OF TENNESSEE
OFFICE OF THE ATTORNEY GENERAL
December 2, 2014
Opinion No. 14-103
Taxation of Mineral Interests

QUESTIONS

1. Does the taxation of mineral interests using a valuation process based on the income derived from such property during the prior year constitute a tax on a type of income other than income derived from stocks and bonds that are not taxed ad valorem?

2. Does the taxation of mineral interests using a valuation process based on the income derived from such property and the amount of minerals removed from the property during the prior year constitute an additional severance tax on gas and oil production in violation of Tenn. Code Ann. § 60-1-301?

OPINIONS

1. No. Determining the value of real property by using the income approach is a commonly-used, appropriate method for valuing income-producing property for purposes of ad valorem taxation. The use of this approach does not result in the assessment of an income tax.

2. No. Use of the income approach to value mineral interests likewise does not result in the assessment of an unauthorized severance tax.

ANALYSIS

The goal in valuing property for ad valorem tax purposes is to determine "the sound, intrinsic and immediate value of the property for purposes of sale between a willing seller and a willing buyer." Tenn. Att'y Gen. Op. 79-509 (Dec. 4, 1979). "Generally speaking, there are three approaches (or methods) used by appraisers to determine the value of property—the market approach, the income approach, and the cost approach." Tenn. Att'y Gen. Op. 79-44 (Feb. 1, 1979). "Usually, these three approaches are used and are correlated to reach a determination of value." Id.

The income approach to valuation is "essential to appraisal processes." Tenn. Att'y Gen. Op. 77-41 (Feb. 18, 1977). The income approach is "based on the premise that 'the value of a property is equivalent to the present worth of the net income it may be expected to produce during a normal term of ownership or over its remaining economic life.'" Tenn. Att'y Gen. Op. 79-509 (Dec. 4, 1979) (quoting State of Tennessee Assessment Manual, at 31). This approach "is commonly used and appropriate to value income-producing real property." Spring Hill, L.P. v. State Bd. of Equalization, No. M2001-02683-COA-R3-CV, 2003 WL 23099679, at *9 (Tenn. Ct. App. Dec. 31, 2003) (no perm. app. filed).

The use of the income approach to value property does not convert the tax subsequently imposed into an income tax. See, e.g., First Am. Nat'l Bank of Knoxville v. Olsen, 751 S.W.2d 417, 421-22 (Tenn. 1987) (although the amount of excise tax is measured by net earnings that does not convert it into an income tax); Kankakee County Bd. of Review, 544 N.E.2d 762, 772 (Ill. 1989) (recognizing distinction between income tax upon revenue and consideration of same revenue when calculating fair market value of property for ad valorem tax purposes). The use of the income approach results in the assessment of a property tax, and the consideration of the property's income in this process does not change the basic nature of the tax being assessed. Cf. Corn v. Fort, 170 Tenn. 377, 389, 95 S.W.2d 620, 624 (1936) (holding that "a privilege [franchise] tax is not converted into a property tax" despite the fact that both taxes are "measured by the value of property").

In accordance with these principles, it is entirely appropriate for an assessor to use the income approach when valuing mineral interests. To the extent that this interest in real property is generating income, the assessor can and should consider the income in valuing the property. Property containing particularly productive mineral resources will generate more income and possess greater value than a less productive property. The use of the income approach to value such a mineral interest does not result in the imposition of an income tax or severance tax.

HERBERT H. SLATERY III
Attorney General and Reporter

ANDRÉE SOPHIA BLUMSTEIN
Solicitor General

MARY ELLEN KNACK
Senior Counsel

Requested by:
The Honorable Ken Yager
State Senator
G19 War Memorial Building
Nashville Tennessee 37243