If a Tennessee LLC taxed as a partnership makes a federal IRC Section 754 election, do the resulting basis step-ups under Sections 743(b) and 734(b) also affect the LLC's Tennessee excise tax net earnings?

Plain-English summary

An LLC taxed federally as a partnership has an IRC § 754 election in effect -- a technical federal tax mechanism that lets a partnership adjust its "inside" asset basis to match a member's actual purchase price or to reflect a property distribution, avoiding distortions that otherwise happen when partnership assets have appreciated. The ruling walks through Tennessee's excise tax treatment of the two different flavors of § 754 basis adjustment:

Flavor 1 — IRC § 743(b): triggered by a SALE of a member's interest. When one member sells her whole interest to a new "purchasing member," a § 754 election lets the entity step up (or down) the purchasing member's own personal basis in the entity's assets to match what she actually paid — but this adjustment is strictly personal to that one purchasing member. Federal regulations are explicit that it "has no effect on the partnership's computation of its taxable income" — the entity itself keeps computing its own income and gain using its unadjusted "common" basis; the § 743(b) adjustment only shows up later, as a separate line-item tweak to that one member's own K-1 share, for the purpose of THAT MEMBER's individual federal return.

Because Tennessee's excise tax "net earnings" are computed at the entity level (starting from the entity's own federal ordinary income, which is based on its common, unadjusted basis), and Tennessee's statute lists specific addition/subtraction adjustments that do NOT include anything about a purchasing member's personal distributive-share tweak, the § 743(b) adjustment simply never enters the calculation. The entity's Tennessee net earnings from selling that asset are unaffected by the § 743(b) step-up — full stop, regardless of what happens on the purchasing member's individual federal return.

Flavor 2 — IRC § 734(b): triggered by a DISTRIBUTION of property to a member. This is fundamentally different: when the entity distributes an asset to a member and that triggers gain or loss to the member, § 734(b) requires the ENTITY ITSELF to adjust its own basis in its REMAINING property. This isn't a personal, one-member-only adjustment — it changes the entity's own common basis going forward.

Because Tennessee's net earnings computation starts from the entity's own federal ordinary income, and that federal income calculation on a later sale of remaining property will reflect the § 734(b)-adjusted basis, the adjustment flows straight through into Tennessee net earnings too — not because Tennessee specifically "adopts" § 734(b), but simply because it's baked into the entity-level federal income figure Tennessee starts from.

The Department's overarching framing: Tennessee's F&E tax law "neither recognizes nor disallows" a § 754 election as such — there's no Tennessee-specific rule about the election itself. What matters is simply tracing through, mechanically, whose basis each type of adjustment actually changes (the individual member's, for § 743(b); or the entity's own, for § 734(b)) and whether that change shows up in the figure — the entity's federal ordinary income — that Tennessee's excise tax starts from.

What this means for you

LLCs and partnerships doing business in Tennessee with a Section 754 election

Don't assume every § 754-related basis adjustment flows through to your Tennessee excise tax the same way. A member-level § 743(b) step-up from an interest sale is invisible to the entity's own Tennessee tax return — it only affects that one member's individual federal filing. But an entity-level § 734(b) adjustment from a property distribution DOES affect the entity's own future Tennessee net earnings, because it changes the entity's own basis that flows into its federal (and therefore Tennessee) income computation.

Accountants and tax professionals

This ruling is a clean, mechanically precise walk-through of the § 743(b) vs. § 734(b) distinction and its Tennessee excise-tax consequences — useful any time a Tennessee partnership/LLC client has a § 754 election in effect and is trying to reconcile entity-level Tennessee net earnings against a member's individually-adjusted K-1 figures. The key takeaway to apply elsewhere: Tennessee's excise tax starts from the ENTITY's federal ordinary income (§ 67-4-2006(a)(4)(A)), so any federal adjustment that is purely personal to one partner/member (rather than baked into the entity's own income figure) generally won't independently affect Tennessee net earnings absent a specific Tennessee statutory adjustment.

Common questions

Q: If a partnership steps up a new partner's basis after they buy into the LLC, does that reduce the LLC's own Tennessee excise tax when it later sells the stepped-up asset?
A: No. An IRC § 743(b) basis adjustment only affects that individual purchasing member's own personal basis and distributive share for federal tax purposes — it has no effect on the entity's own common basis or its Tennessee net earnings computation.

Q: What about a basis adjustment after the LLC distributes property to a member?
A: That's different — an IRC § 734(b) adjustment changes the ENTITY's own basis in its remaining property, so it does flow through into the entity's federal ordinary income (and therefore its Tennessee net earnings) when that remaining property is later sold.

Q: Does Tennessee have its own special rules for Section 754 elections?
A: No. Tennessee's franchise and excise tax laws neither specifically recognize nor disallow a § 754 election — the Tennessee tax result simply follows from whether a given basis adjustment is reflected in the entity's own federal ordinary income.

Q: Can another LLC or partnership rely on this Revenue Ruling?
A: No. Tennessee Revenue Rulings are explicitly advisory and NOT binding on the Department, even for the requesting taxpayer. It illustrates the Department's reasoning, but confirm your own entity's facts with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-4-2006(a)(4)(A) (Supp. 2010) (net earnings/loss of a federally-partnership-classified taxpayer = federal ordinary income/loss plus specified additional items)
• § 67-4-2006(b)-(c) (Supp. 2010) (specific addition/subtraction adjustments -- no provision addresses a § 743(b) distributive-share adjustment)
• §§ 67-4-2007(a), 67-4-2004(37) (Supp. 2010) (excise tax on net earnings, including LLCs)

Federal statutes and regulations cited by the ruling:

• I.R.C. § 754 (election to adjust basis under §§ 734(b) and 743(b))
• I.R.C. § 743(b) (member-specific basis adjustment upon sale/exchange of a partnership interest)
• I.R.C. § 734(b) (entity-level basis adjustment upon distribution of property to a partner)
• I.R.C. §§ 703, 704 (partnership taxable income computation and distributive shares)
• I.R.C. § 755 (allocation of basis adjustment among partnership assets)
• I.R.C. §§ 1001(a), 1011(a) (gain/loss computation on sale of partnership property)
• Treas. Reg. §§ 1.743-1(b), (e), (j)(1)-(3) (mechanics of the § 743(b) adjustment; no effect on partnership's own taxable income computation)
• Treas. Reg. § 1.754-1(a) (mechanics of the § 734(b) adjustment upon a property distribution)

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/11-45fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 11-45
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
The determination for Tennessee excise tax purposes of a limited liability company’s net
earnings or loss, where the limited liability company has in effect an election under Section 754
of the Internal Revenue Code of 1986, as amended.
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
The Taxpayer is organized as a limited liability company (an “LLC”) and is classified as a
partnership for federal income tax purposes. The Taxpayer does business in Tennessee. The
Taxpayer is owned by two members, one of whom sells his entire interest in the Taxpayer to a
third party (the “purchasing member”). In the same taxable year in which the sale of the
member’s interest occurs, the Taxpayer makes an election under Section 754 of the Internal
Revenue Code of 1986, as amended (an “IRC § 754 election”), such that the purchasing
member’s basis in the Taxpayer’s assets is stepped up under Section 743(b) of the Internal
Revenue Code (an “IRC § 743(b) basis adjustment”) to the amount that the purchasing member
paid for the selling member’s interest. Subsequently, the Taxpayer sells an asset that was
allocated a portion of the IRC § 743(b) basis adjustment, resulting in gain to the Taxpayer.

Alternatively, the Taxpayer distributes an asset to one of its members, and then steps up its basis
in the remaining partnership property in accordance with Section 734(b) of the Internal Revenue
Code (an “IRC § 734(b) basis adjustment”). The Taxpayer then sells an asset that was allocated a
portion of the IRC § 734(b) basis adjustment, resulting in gain to the Taxpayer.
QUESTIONS
1.

Is the adjustment to the purchasing member’s distributive share of gain or loss from the
sale of an asset, resulting from an IRC § 743(b) basis adjustment as part of an IRC § 754
election, taken into account in determining the Taxpayer’s net earnings or loss for
Tennessee excise tax purposes?

2.

Is the adjustment to the Taxpayer’s basis in its assets resulting from the distribution of an
asset to a member and the corresponding IRC § 734(b) basis adjustment as part of an IRC
§ 754 election taken into account in determining the Taxpayer’s net earnings or loss for
Tennessee excise tax purposes upon a subsequent sale of a different Taxpayer asset?
RULINGS

The Tennessee franchise and excise tax laws neither recognize nor disallow an IRC § 754
election. Rather, each taxpayer must calculate its individual Tennessee tax liability in accordance
with the applicable franchise and excise tax provisions.
1.

For Tennessee excise tax purposes, the Taxpayer’s net earnings or loss will be
determined without making any addition or subtraction relating to the adjustment to the
purchasing member’s distributive share of partnership gain or loss from the sale of an
asset that was allocated a portion of the IRC § 743(b) basis adjustment pursuant to an
IRC § 754 election, because the adjustment to the purchasing member’s distributive share
does not constitute an additional item of income or loss to the Taxpayer.

2.

The Taxpayer’s net earnings or loss for Tennessee excise tax purposes are determined
based upon the Taxpayer’s federal ordinary income, as adjusted under TENN. CODE ANN.
§ 67-4-2006 (Supp. 2010). Therefore, upon a subsequent sale of a different Taxpayer
asset, the Taxpayer’s net earnings or loss will reflect any adjustment to the Taxpayer’s
basis in its assets resulting from the distribution of an asset to a member and the
corresponding IRC § 734(b) basis adjustment as part of an IRC § 754 election, to the
extent such adjustment is reflected in the Taxpayer’s federal ordinary income.
ANALYSIS

1.

The IRC § 743(b) basis adjustment and the Tennessee excise tax
a.

Overview of the IRC § 743(b) basis adjustment

For federal income tax purposes, when an interest in an entity that is taxed as a partnership is
sold, the amount paid becomes the purchaser’s basis in the newly acquired partnership interest
(also known as “outside basis”). Additionally, the purchaser assumes the seller’s pro rata share of
the partnership’s adjusted basis in its property (also known as “inside basis”). If the partnership’s

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assets have appreciated sufficiently, the difference between the new partner’s inside and outside
basis can be substantial; this disparity can deprive the new partner of depreciation deductions and
inflate his share of the gain from subsequent property dispositions. To avoid such undesired
effects, the partnership has the option of making an IRC § 754 election to equalize the new
partner’s inside and outside basis pursuant to an IRC § 743(b) basis adjustment. The IRC § 754
election is effective with respect to the taxable year in which the election is made, as well as all
subsequent taxable years.
By making the IRC § 754 election, the partnership causes the purchaser’s inside basis to increase
or decrease so that it equals the purchaser’s outside basis. Specifically, Treas. Reg. § 1.743-1(b)
provides that, in the case of the transfer of an interest in a partnership by sale or exchange, a
partnership either: 1) increases the adjusted basis of partnership property by the excess of the
transferee’s basis for the transferred partnership interest over the transferee’s share of the
adjusted basis to the partnership of the partnership’s property; or 2) decreases the adjusted basis
of partnership property by the excess of the transferee’s share of the adjusted basis to the
partnership of the partnership’s property over the transferee’s basis for the transferred
partnership interest. Treas. Reg. § 1.743-1(e) requires that the basis adjustment made pursuant to
IRC § 743(b) be allocated among the individual items of partnership property in accordance with
IRC § 755 (for purposes of this revenue ruling, an asset that was allocated a portion of the IRC
§ 743(b) basis adjustment will be referred to as an “IRC § 743(b) asset”).
IRC § 743(b) and Treas. Reg. § 1.743-1(j)(1) provide that the IRC § 743(b) basis adjustment
constitutes an adjustment to the basis of partnership property with respect to the transferee
partner only; no adjustment is made to the common basis of partnership property. As a result, the
adjustment to the purchasing partner’s inside basis under IRC § 743(b) has no effect on the
partnership’s computation of its taxable income. See Treas. Reg. § 1.743-1(j)(3)(ii) (Examples 13). Rather, the IRC § 754 election affects only the purchaser’s distributive share of items of
partnership income, deduction, gain, or loss that relate to a partnership asset that was allocated a
portion of the basis adjustment pursuant to the IRC § 754 election.
Treas. Reg. § 1.743-1(j)(2) sets forth the method for computing the partnership’s income and the
partners’ distributive shares of items of partnership income, deduction, gain, or loss when the
partnership has an IRC § 754 election in effect. First, the partnership computes its items of
income, deduction, gain, or loss at the partnership level under IRC § 703.1 Next, the partnership
allocates the partnership items among the partners in accordance with IRC § 704,2 and adjusts
the partners’ capital accounts accordingly. The partnership then adjusts the purchaser’s
distributive shares of the items of partnership income, deduction, gain, or loss to reflect the
effects of the purchaser’s basis adjustment under IRC § 743(b). These adjustments to the
purchaser’s distributive shares do not affect the purchaser’s capital account. Adjustments to the

1

IRC § 703 states that a partnership shall compute its taxable income in the same manner as an individual, except
that the partnership must separately state certain items of gain, loss or deduction, and cannot claim certain
deductions allowed to individuals.
2

IRC § 704 provides that, with certain exceptions, a partner’s distributive share of income, gain, loss, deduction, or
credit is determined by the partnership agreement.

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purchaser’s distributive shares must be reflected on Schedules K and K-1 of the partnership’s
federal income tax return. No adjustment is made to the distributive shares of the other partners.
b.

The IRC § 743(b) basis adjustment and the Tennessee excise tax

For Tennessee excise tax purposes, the Taxpayer’s net earnings or loss will be determined
without making any addition or subtraction relating to the adjustment to the purchasing
member’s distributive share of partnership gain or loss from the sale of an asset that was
allocated a portion of the IRC § 743(b) basis adjustment pursuant to an IRC § 754 election,
because the adjustment to the purchasing member’s distributive share does not constitute an
additional item of income or loss to the Taxpayer.
Tennessee imposes an excise tax on the net earnings of certain persons, including limited
liability companies, doing business within Tennessee. TENN. CODE ANN. §§ 67-4-2007(a) (Supp.
2010) and 67-4-2004(37) (Supp. 2010). TENN. CODE ANN. § 67-4-2006(a)(4)(A) defines “net
earnings” or “net loss” of a taxpayer that is treated as a partnership for federal tax purposes as an
amount equal to “the amount of ordinary income or loss determined under the applicable
provisions of the Internal Revenue Code, including, but not limited to, guaranteed payments to
partners and capital gains, which additional items are not already included in ordinary income or
loss.” This amount is further adjusted as set forth in TENN. CODE ANN. § 67-4-2006(b)-(c), which
requires specific addition and subtraction adjustments to arrive at a taxpayer’s net earnings or
loss. Importantly, TENN. CODE ANN. § 67-4-2006(b)-(c) does not provide for the addition to, or
subtraction from, a taxpayer’s net earnings or loss of an amount equal to the adjustment made to
a purchasing partner’s distributive share of partnership income or loss from the sale of an IRC
§ 743(b) asset. No other provision in the Tennessee excise tax law requires or otherwise allows
such an adjustment to net earnings or loss.
The starting point for calculating the Taxpayer’s Tennessee net earnings or loss is therefore its
federal ordinary income or loss, as determined under the Internal Revenue Code. If the
Taxpayer’s ordinary income does not already include items of income or loss such as guaranteed
payments to partners, dividend and interest income, and capital gains or losses, the Taxpayer
must add such items to its net earnings or loss in accordance with TENN. CODE ANN. § 67-42006(a)(4)(A). Thus, if the Taxpayer’s ordinary income does not already include the gain or loss
from the sale during the taxable year of an IRC § 743(b) asset, the Taxpayer must add such gain
or loss to its ordinary income.
To determine its income or loss from the sale of an IRC § 743(b) asset under the applicable
provisions of the Internal Revenue Code, the Taxpayer must use its common basis in the asset.
Under IRC § 1001(a), the Taxpayer’s gain from the sale of partnership property equals the
excess of the amount realized from the sale over the Taxpayer’s adjusted basis in the asset. In the
case of a loss, the loss equals the excess of the Taxpayer’s adjusted basis in the asset over the
amount realized from the sale. IRC § 1011(a) provides that, in the case of a partnership, the
adjusted basis for determining the gain or loss from the sale of property shall be the basis
determined under Subchapter K (i.e., the portion of the Internal Revenue Code relating to
partners and partnerships) and other applicable provisions.
Under the Internal Revenue Code, the Taxpayer’s gain or loss on the sale of an IRC § 743(b)
asset is determined based on the common basis of the partnership property; the adjustment to the
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purchasing member’s inside basis under IRC § 743(b) has no effect on the common basis of
partnership property. Treas. Reg. § 1.743-1(j)(1); see also Treas. Reg. § 1.743-1(j)(3)(ii)
(Examples 1-3). As discussed in detail above, IRC § 743(b) and Treas. Reg. § 1.743-1(j)(1)
provide that the IRC § 743(b) basis adjustment constitutes an adjustment to the basis of
partnership property with respect to the transferee partner only. In other words, the Taxpayer’s
gain or loss on the subsequent sale of an IRC § 743(b) asset is not determined based on the
purchasing member’s inside basis. Thus, to determine the amount of gain or loss from the sale
during the taxable year of an IRC § 743(b) asset that must be included in the Taxpayer’s
Tennessee net earnings or loss, the Taxpayer must use the common basis of the partnership
property.
Importantly, the adjustment to the purchasing member’s distributive share of income or loss
from the sale of an IRC § 743(b) asset does not constitute an “additional item” of income or loss
that must be included in the Taxpayer’s net earnings or loss under TENN. CODE ANN. § 67-42006(a)(4)(A). Simply stated, the Taxpayer’s income or loss from the sale of an IRC § 743(b)
asset is determined first, based on the common basis of the partnership property. Next, for the
ultimate purpose of determining the purchasing member’s federal taxable income, the Taxpayer
makes an adjustment to the purchasing member’s distributive share of that item of income or loss
in accordance with Treas. Reg. § 1.743-1(j)(2), discussed above. The adjustment to the
purchasing member’s distributive share does not change the amount of income or loss realized
by the Taxpayer upon the sale of the IRC § 743(b) asset. Thus, the Taxpayer will not increase or
decrease its net earnings or loss by the amount of the adjustment to the purchasing member’s
distributive share of gain or loss from the sale of an IRC § 743(b) asset.
Accordingly, for Tennessee excise tax purposes, the Taxpayer’s net earnings or loss will be
determined without making any addition or subtraction relating to the adjustment to the
purchasing member’s distributive share of partnership gain or loss from the sale of an asset that
was allocated a portion of the IRC § 743(b) basis adjustment pursuant to an IRC § 754 election.
2.

The IRC § 734(b) basis adjustment and the Tennessee excise tax
a.

Overview of the IRC § 734(b) basis adjustment

When a partnership that has made an IRC § 754 election distributes property to a partner, the
partnership must adjust its basis in the remaining partnership property (i.e., inside basis) as set
forth in IRC § 734(b). See Treas. Reg. § 1.754-1(a). IRC § 734(b) provides that, upon the
distribution of partnership property to a partner, the partnership must increase the adjusted basis
of the remaining partnership property by the amount of any gain recognized to the distributee
partner with respect to the distribution, or in the case of a loss, decrease the adjusted basis of the
remaining partnership property by the amount of any loss recognized to the distributee partner.
IRC § 734(c) requires that the basis adjustment made pursuant to IRC § 734(b) be allocated
among the remaining individual items of partnership property in accordance with IRC § 755.
b.

The IRC § 734(b) basis adjustment and the Tennessee excise tax

The Taxpayer’s net earnings or loss for Tennessee excise tax purposes are determined based
upon the Taxpayer’s federal ordinary income, as adjusted under TENN. CODE ANN. § 67-4-2006.
Therefore, upon a subsequent sale of a different Taxpayer asset, the Taxpayer’s net earnings or
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loss will reflect any adjustment to the Taxpayer’s basis in its assets resulting from the
distribution of an asset to a member and the corresponding IRC § 734(b) basis adjustment as part
of an IRC § 754 election, to the extent such adjustment is reflected in the Taxpayer’s federal
ordinary income.
As discussed above, TENN. CODE ANN. § 67-4-2006(a)(4)(A) defines “net earnings” or “net loss”
of a taxpayer that is treated as a partnership for federal tax purposes as an amount equal to “the
amount of ordinary income or loss determined under the applicable provisions of the Internal
Revenue Code, including, but not limited to, guaranteed payments to partners and capital gains,
which additional items are not already included in ordinary income or loss.” When a taxpayer
treated as a partnership sells an asset that was allocated a portion of the IRC § 734(b) basis
adjustment (an “IRC § 734(b) asset”), the gain or loss from the sale (as determined under the
applicable provisions of the Internal Revenue Code) will therefore be included in the taxpayer’s
Tennessee net earnings or loss, by virtue of being included in its federal ordinary income.
To determine its income or loss from the sale of an IRC § 734(b) asset under the applicable
provisions of the Internal Revenue Code, the Taxpayer must use the adjusted basis in the asset
that resulted from the IRC § 734(b) basis adjustment. Under IRC § 1001(a), the Taxpayer’s gain
from the sale of partnership property equals the excess of the amount realized from the sale over
the Taxpayer’s adjusted basis in the asset. In the case of a loss, the loss equals the excess of the
Taxpayer’s adjusted basis in the asset over the amount realized from the sale. IRC § 1011(a)
provides that, in the case of a partnership, the adjusted basis for determining the gain or loss
from the sale of property shall be the basis determined under Subchapter K (the portion of the
Internal Revenue Code relating to partners and partnerships) and other applicable provisions. In
the case of an IRC § 734(b) asset, the Taxpayer’s adjusted basis in the asset is therefore the basis
that resulted from the IRC § 734(b) basis adjustment.
Accordingly, upon a subsequent sale of a different Taxpayer asset, the Taxpayer’s net earnings
or loss will reflect any adjustment to the Taxpayer’s basis in its assets resulting from the
distribution of an asset to a member and the corresponding IRC § 734(b) basis adjustment as part
of an IRC § 754 election, to the extent such adjustment is reflected in the Taxpayer’s federal
ordinary income.

Kristin Husat
Senior Tax Counsel

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

9-15-11

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