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combined basis on Schedule F1, Captive “which is subject to and files a return Sales of interests in Tennessee
Real Estate Investment Trust Net Worth, of for the tax imposed by this part” (Tenn. regarded but federally
Form FAE 174. Code §§67-4-2006(b)(1)(J) and (2)(L)). disregarded entities
This is because the passthrough entity’s One of the many questions that arise
Nonflowthrough of nexus, taxable taxable income does not flow through to due to the partial nonconformity to the
income, and apportionment for the passthrough owner. No adjustment federal entity classification rules concerns
Tennessee passthrough entities is made for income or loss attributable the Tennessee excise tax consequences
As a result of Tennessee’s separately to general partnerships, because general of the sale of a federally disregarded, but
taxing many federal disregarded or partnerships are not subject to Tennessee Tennessee regarded, entity. Consider, for
passthrough entities, these separately FAE tax at the entity level. instance, an SMLLC owned by a limited
taxed entities, with a few defined excep- In contrast, for federal income tax partnership. For federal income tax
tions, do not flow through income or purposes, passthrough entities are not purposes, the sale of a disregarded entity
loss or apportionment factors to their generally the taxpayer. The income or is treated as the sale of the entity’s assets.
partners or members. Instead, those enti- loss of passthrough entities generally However, does the same result ensue for
ties themselves are subject to Tennessee flows through to the individual or cor- Tennessee excise tax purposes?
tax. This affects the nexus, taxable in- porate partners. As a result, Tennessee’s In other words, on the sale of the
come, and apportionment of the upper- conformity to federal taxable income LLC interest:
tier entities. differs based on whether the entity is ■ Does the LLC report the gain as an
Nexus: Regarding nexus, owner- taxed federally as a C corporation, S asset sale (as it is reported for federal
ship of an interest in a limited liability corporation, partnership, business trust, purposes); or
passthrough entity taxable in Tennessee SMLLC owned by an individual or a ■ Does the partnership report the
by itself will not create nexus. As stated general partnership, etc. (Tenn. Code gain respecting the legal form of the
in the Tennessee Department of Rev- §§67-4-2006(a)(1)–(9)). transaction as the sale of an interest
enue’s Franchise and Excise Tax Manual For a federally disregarded but in an LLC (as the LLC is a taxable
(ch. 3, pg. 51): Tennessee regarded entity, Tennessee entity for Tennessee FAE purposes)?
considers the classification of the feder- The answer may significantly change
Each taxable entity stands on its own ally disregarded entity to be the same the taxability of the transaction, as the
attributes as to whether it is doing classification as the entity it is regarded upper-tier partnership may not separate-
business and has substantial nexus in into (see, e.g., Tenn. Letter Ruling No. ly have nexus with Tennessee. Therefore,
the state. An ownership interest in a 11-46 (Sept. 12, 2011)). Therefore, if a if the partnership is regarded as selling
passthrough entity (e.g., an LP, LLC, federally disregarded LLC is disregarded the LLC interest, this transaction may
or S corp.) that operates in Tennessee into a partnership, the entity would not be taxed by Tennessee. If the LLC
does not create a franchise and excise compute federal taxable income for Ten- is regarded as the seller, the transaction
tax filing requirement for the owner. nessee excise tax purposes as if it were would be taxed by Tennessee.
a partnership. Tenn. Rev. Rul. No. 11-53 (Sept. 22,
However, because corporate-owned Apportionment factors: As with 2011) appears to obliquely address the
SMLLCs are disregarded, an ownership income or loss, apportionment fac- issue. The facts in this ruling are com-
interest in an SMLLC with Tennessee tors do not flow through to upper-tier plicated, but the key fact is that, as part
nexus will subject the corporate member partners or members from limited of an overall transaction, an entity taxed
to FAE taxes. The same is true of an liability passthrough entities that are as a partnership for Tennessee excise tax
interest in a general partnership doing subject to Tennessee FAE taxes and file purposes sold an interest in a French en-
business in Tennessee. And, of course, the appropriate returns. In computing tity (not an LLC). The French entity was
if the partner or member otherwise is Tennessee apportionment, the statutes federally disregarded but regarded for
doing business in or has substantial require only property, payroll, and sales Tennessee FAE tax purposes. The ruling
nexus with Tennessee, that could inde- related to general partnerships and to states that the entity taxed as a partner-
pendently create nexus. limited liability passthrough entities that ship “will not include in its Tennessee net
Taxable income: In computing are “not doing business in Tennessee and earnings any gain from the Transaction
Tennessee net earnings, a passthrough thus [are] not subject to Tennessee excise that is attributable to” the French entity.
owner’s federal taxable income must tax” to be added to the upper-tier part- For federal purposes, as the French
be adjusted for any item of income or ner’s or member’s factors (Tenn. Code entity was disregarded, the sale would
loss attributable to a passthrough entity §§67-4-2012(b), (e), and (g)). have been treated as a sale of the assets

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