If a chain of disregarded single-member LLCs is ultimately owned by a tax-exempt governmental pension plan, is the bottom-tier LLC subject to Tennessee franchise and excise tax?

Plain-English summary

A chain of single-member LLCs sits beneath a tax-exempt governmental pension plan ("GOVERNMENTAL PLAN") — an organization described in Internal Revenue Code § 401(a), treated as a trust rather than a corporation. GOVERNMENTAL PLAN owns "IntermediateCo I," which owns "IntermediateCo II," which owns the Taxpayer, an LLC whose sole purpose is to hold Tennessee real property and pass the rental income (after expenses) up the chain to GOVERNMENTAL PLAN. All three LLCs — IntermediateCo I, IntermediateCo II, and the Taxpayer — are disregarded for federal income tax purposes, meaning the Taxpayer is treated as just a division of GOVERNMENTAL PLAN for federal tax purposes. The Taxpayer asked whether it owes Tennessee franchise and excise (F&E) tax. The Department's answer: generally not, because it's a "not-for-profit" — but not entirely off the hook.

Why the LLC counts as "not-for-profit." Tennessee's F&E tax generally applies to "persons" doing business in the state, including LLCs (§ 67-4-2004(37); § 67-4-2007(a); §§ 67-4-2105(a), -2106(a)). But Tennessee excludes "not-for-profit" entities — defined as "any person described in" several Internal Revenue Code sections, including § 401, 501, and others (§ 67-4-2004(33)). GOVERNMENTAL PLAN is described in I.R.C. § 401(a) and exempt from federal income tax under I.R.C. § 501(a). Because the Taxpayer is disregarded for federal income tax purposes and treated as a division of GOVERNMENTAL PLAN, it's exempt for federal purposes to the same extent and under the same provisions as GOVERNMENTAL PLAN — making the Taxpayer itself "described in" § 401(a), and therefore a "not-for-profit" under Tennessee's definition too. (The Department noted this conclusion holds regardless of whether the LLC is separately treated for franchise/excise purposes specifically — the not-for-profit determination follows GOVERNMENTAL PLAN's status either way.)

The exclusion isn't absolute. Even as a not-for-profit, the Taxpayer remains subject to Tennessee excise tax on any net earnings that would be unrelated business taxable income (UBTI) under I.R.C. § 512, or that are otherwise subject to federal income tax under Subchapter A of the Internal Revenue Code — and on net earnings from any activity unrelated to and outside the scope of what gave it exempt status in the first place (§ 67-4-2007(a)). Parallel rules apply to the franchise tax: the Taxpayer is subject to franchise tax on the portion of its Tennessee net worth or property attributable to UBTI-generating activities, and on the portion attributable to unrelated activities (§ 67-4-2105(b)).

What this means for you

Real estate or investment LLCs owned through a chain of disregarded entities under a tax-exempt parent (pension fund, governmental plan, charity)

If your LLC is genuinely disregarded for federal income tax purposes all the way up to a § 401/§ 501-exempt parent, you likely qualify as a "not-for-profit" for Tennessee F&E purposes too — even though you're a multi-tier LLC structure, not the exempt entity itself. But that's not a blanket exemption: watch for unrelated business activities or income that would be UBTI at the federal level, since those slices stay taxable in Tennessee.

Pension funds, governmental plans, and tax-exempt investors using disregarded LLC holding structures

This confirms Tennessee follows the federal disregarded-entity classification when determining not-for-profit status, rather than requiring the holding LLC itself to independently qualify as exempt. Structure and document the disregarded-entity chain carefully, since the whole analysis depends on it.

Accountants and tax professionals

Compare this to LR 12-17 (job tax credit survives sale of a disregarded SMLLC) — both rulings turn on Tennessee's general rule that a single-member LLC disregarded for federal income tax purposes is treated as a division of its owner for F&E purposes. Here that principle extends not-for-profit STATUS down through a multi-tier disregarded chain; there it kept a credit WITH the parent after a sale. Note the excise/franchise UBTI carve-backs (§§ 67-4-2007(a), -2105(b)) apply even to entities that otherwise qualify.

Common questions

Q: Is an LLC disregarded up to a tax-exempt parent automatically exempt from Tennessee F&E tax?
A: Generally yes, as a "not-for-profit" under § 67-4-2004(33) — but it remains subject to excise tax on UBTI/unrelated-activity earnings and franchise tax on the related portion of its net worth/property.

Q: Does it matter how many tiers of disregarded LLCs sit between the exempt parent and the Tennessee property?
A: Not under these facts — the Department traced the disregarded-entity chain through two intermediate LLCs to reach the same conclusion as if the Taxpayer held the property directly.

Q: What is "unrelated business taxable income" and why does it matter here?
A: UBTI (I.R.C. § 512) is income a tax-exempt entity earns from activities unrelated to its exempt purpose. Even a not-for-profit entity under Tennessee's F&E rules stays taxable on UBTI-type earnings and the related net worth/property.

Q: Can I rely on this letter ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts it was issued to, and it can be revoked or modified. Confirm your own situation with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-4-2004(37) (Supp. 2012) (definition of "persons" subject to F&E tax, including LLCs); § 67-4-2007(a) (2011) (6.5% excise tax on net earnings); §§ 67-4-2105(a), -2106(a) (2011) ($0.25 per $100 franchise tax on net worth)
• § 67-4-2004(33) (definition of "not-for-profit" — any person described in I.R.C. §§ 401, 408, 408A, 409, 501, 526, 527, 528, 529, or 530)
• § 67-4-2007(a) (not-for-profit excise tax exclusion, with carve-back for UBTI/Subchapter-A-taxable and unrelated-activity net earnings); § 67-4-2105(b) (not-for-profit franchise tax exclusion, with parallel carve-back for net worth/property)
• §§ 67-4-2007(d), -2007(e)(1), -2106(c) (disregarded-entity rules for F&E filing, referenced but not addressed); Tenn. Code Ann. § 48-101-706 (2012) (referenced)

Federal authority cited by the ruling:

• I.R.C. § 414(d) (definition of "governmental plan"); I.R.C. § 401(a) (qualified-plan/exempt-organization description); I.R.C. § 501(a) (federal income tax exemption for organizations described in § 501(c)/(d) or § 401(a)); I.R.C. § 512 (unrelated business taxable income)
• Treas. Reg. § 301.7701-4 (trust classification); Treas. Reg. § 301.7701-2(a) (a disregarded entity is treated as a division of its owner)

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/12-26fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 12-26

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 practitioner before relying on any aspect of this ruling.
SUBJECT
Whether a limited liability company that is disregarded for federal income tax purposes to an
entity described in Section 401(a) of the Internal Revenue Code of 1986, as amended, is
considered a not-for-profit entity for Tennessee franchise and excise tax purposes.
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
[GOVERNMENTAL PLAN] is a “governmental plan” within the meaning of Section 414(d) of
the Internal Revenue Code of 1986, as amended, and is an organization described in Section
401(a) and the relevant U.S. Treasury regulations. [REDACTED]. [GOVERNMENTAL PLAN]
is not a corporation; rather, [GOVERNMENTAL PLAN] is treated as a trust under Treas. Reg.
§ 301.7701-4.

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[GOVERNMENTAL PLAN] is the sole member of [ENTITY NAME], a [REDACTED] limited
liability company (“IntermediateCo I”). Intermediate Co I is the sole member of [ENTITY
NAME], a [REDACTED] limited liability company (“IntermediateCo II”). IntermediateCo II is
the sole member of [TAXPAYER], a limited liability company (the “Taxpayer”).
IntermediateCo I, IntermediateCo II, and the Taxpayer are disregarded for federal income tax
purposes. Accordingly, the Taxpayer is treated as a division of [GOVERNMENTAL PLAN] for
federal income tax purposes under Treas. Reg. § 301.7701-2(a).
The Taxpayer’s sole purpose for existence is [TO HOLD PROPERTY] located in Tennessee and
to pay the income therefrom, less expenses, to [GOVERNMENTAL PLAN].
RULING
Is the Taxpayer subject to the Tennessee franchise and excise taxes?
Ruling: For Tennessee franchise and excise tax purposes, the Taxpayer is a not-for-profit
entity. The Taxpayer is therefore generally not subject to Tennessee franchise and excise
taxation.
However, as a not-for-profit entity, the Taxpayer is subject to the Tennessee excise tax to
the extent its net earnings constitute unrelated business taxable income as defined in
I.R.C. § 512, or are otherwise subject to income taxes under Subchapter A of the Internal
Revenue Code. Additionally, the Taxpayer is subject to the Tennessee excise tax on all
net earnings that are attributable to any activities unrelated to and outside the scope of the
activities that give it exempt status.
Similarly, the Taxpayer is subject to the Tennessee franchise tax with respect to its
Tennessee net worth, or real or tangible personal property owned or used, that is
attributable to activities subject to income taxes under I.R.C. § 512 or any other provision
of Subchapter A of the Internal Revenue Code. Additionally, the Taxpayer is subject to
the franchise tax on all of its Tennessee net worth, or real or tangible personal property
owned or used, that is attributable to any activities that are unrelated to and outside the
scope of the activities that gave the Taxpayer its exempt status.
ANALYSIS
Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons, as defined
under TENN. CODE ANN. § 67-4-2004(37) (Supp. 2012), doing business within Tennessee. TENN.
CODE ANN. § 67-4-2007(a) (2011). 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,
pursuant to TENN. CODE ANN. §§ 67-4-2105(a), -2106(a) (2011). Persons subject to the
Tennessee franchise and excise taxes include, but are not limited to, limited liability companies.
TENN. CODE ANN. § 67-4-2004(37).
The Taxpayer is a limited liability company doing business within Tennessee. Accordingly, the
Taxpayer will be subject to Tennessee franchise and excise taxation, unless an exemption or
exclusion from taxation applies.

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One such exclusion from the Tennessee franchise and excise taxes generally applies to persons
having not-for-profit status. TENN. CODE ANN. §§ 67-4-2007(a), -2105(a). The term “not-forprofit” is defined as “any person described in §§ 401, 408, 408A, 409, 501, 526, 527, 528, 529 or
530 of the Internal Revenue Code, codified in 26 U.S.C. §§ 401, 408, 408A, 409, 501, 526, 527,
528, 529 or 530.” TENN. CODE ANN. § 67-4-2004(33). I.R.C. § 501(a) is applicable here,
exempting from federal income taxation “[a]n organization described in subsection 501 or
(d) or section 401(a).”1
[GOVERNMENTAL PLAN] is a “governmental plan” within the meaning of I.R.C. § 414(d)
and is an organization described in I.R.C. § 401(a). As an organization described in I.R.C.
§ 401(a), [GOVERNMENTAL PLAN] is exempt for federal income tax purposes under I.R.C.
§ 501(a). The Taxpayer is disregarded to [GOVERNMENTAL PLAN] for federal income tax
purposes, and as such is treated as a division of [GOVERNMENTAL PLAN] for federal income
tax purposes. See Treas. Reg. § 301.7701-2(a). As a division of [GOVERNMENTAL PLAN],
the Taxpayer is exempt for federal income tax purposes to the same extent, and pursuant to the
same Internal Revenue Code provisions, as [GOVERNMENTAL PLAN]. Thus, the Taxpayer is
exempt for federal income tax purposes under I.R.C. § 501(a) as an organization described in
I.R.C. § 401(a).
Because the Taxpayer is an organization described in I.R.C. § 401(a), it is a “not-for-profit” for
purposes of the Tennessee franchise and excise taxes. The Taxpayer is therefore generally not
subject to Tennessee franchise and excise taxation.
Note that the determining factor with respect to exemption from the franchise and excise taxes as
a not-for-profit is whether the Taxpayer is a “person described in I.R.C. §§ 401, 408, 408A, 409,
501, 526, 527, 528, 529 or 530.” See TENN. CODE ANN. § 67-4-2004(33). Importantly, the
determination of whether the Taxpayer is a person described in one of these sections of the
Internal Revenue Code depends entirely on whether the Taxpayer is disregarded to
[GOVERNMENTAL PLAN] for federal income tax purposes. As explained above, the Taxpayer
is a person described in I.R.C. § 401(a) because, for federal income tax purposes, it is
disregarded to [GOVERNMENTAL PLAN], which is a person described in I.R.C. § 401(a). In
fact, under the facts presented, the Taxpayer would come within the definition of “not-for-profit”
under TENN. CODE ANN. § 67-4-2004(33) regardless of whether it is treated as a separate or
disregarded entity for franchise and excise tax purposes.2
Despite generally being excluded from Tennessee franchise and excise taxation as a not-forprofit entity, the exclusion for such entities is not absolute. Unless it qualifies for an applicable
exemption, a not-for-profit entity is subject to the Tennessee excise tax to the extent its net
earnings constitute unrelated business taxable income as defined in I.R.C. § 512, or are otherwise
subject to income taxes under Subchapter A of the Internal Revenue Code. TENN. CODE ANN.
§ 67-4-2007(a). Additionally, a not-for-profit entity is subject to the Tennessee excise tax on all
1

I.R.C. § 501(a) also contains exceptions that do not apply in the Taxpayer’s case.

2

See TENN. CODE ANN. §§ 67-4-2007(d), -2007(e)(1), -2106(c); 48-101-706 (2012). Because it is not relevant with
respect to the determination of whether the Taxpayer comes within the definition of “not-for-profit” under TENN.
CODE ANN. § 67-4-2004(33), this letter ruling will not address whether the Taxpayer is treated as a separate or
disregarded entity for franchise and excise tax purposes.

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net earnings that are attributable to any activities unrelated to and outside the scope of the
activities that give it exempt status. Id.
Similarly, unless it qualifies for an applicable exemption, a not-for-profit entity is subject to the
Tennessee franchise tax with respect to its Tennessee net worth, or real or tangible personal
property owned or used, that is attributable to activities subject to income taxes under I.R.C.
§ 512 or any other provision of Subchapter A of the Internal Revenue Code. TENN. CODE ANN.
§ 67-4-2105(b). Additionally, a not-for-profit entity is subject to the franchise tax on all of its
Tennessee net worth, or real or tangible personal property owned or used, that is attributable to
any activities that are unrelated to and outside the scope of the activities that gave it exempt
status. Id.
Consequently, if any of the aforementioned criteria are applicable to the Taxpayer, it will be
subject to Tennessee excise and franchise taxes to the extent indicated above.

Kristin Husat
General Counsel

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

11-14-12

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