Successor Entity is Allowed to Use Tennessee Tax Attributes Following F-Reorganization

By: Tracey Stewart, SALT Senior Associate

At a glance:

• The main takeaway: Despite Tennessee’s rule that generally limits the carryover of state tax attributes, a recent ruling concluded that a successor entity could utilize the predecessor’s net operating losses (NOLs) and tax credits following an F-reorganization.
• Assess the impact: While the ruling provides clarity on utilizing Tennessee tax attributes following an F-reorganization, taxpayers must be aware of the state’s general rule of limiting carryover tax attributes.
• Take the next step: Taxpayers must understand the importance of planning to satisfy the Tennessee Carryover Exception. Aprio’s State and Local Tax (SALT) team can advise you on corporate transactions and reorganizations. 

Schedule a free consultation today to learn more!

The full story

Many states conform to Internal Revenue Code (IRC) § 381, which allows tax attributes (i.e., net operating losses and tax credits) earned by one corporation to carryover to a successor corporation following a qualifying tax-free reorganization. However, some states do not follow this rule generally and/or may impose additional limitations. 

How does the Tennessee Carryover Exception work?

For example, in Tennessee, the general rule under its franchise and excise tax (F&E Tax) is that tax attributes can only be carried forward and used by the taxpayer that generated them.[1] However, there is an exception to this general rule (referred to as the Tennessee Carryover Exception), which allows tax attributes to carryover to a successor taxpayer when a predecessor taxpayer merges out of existence and into a successor taxpayer that has no “income, expenses, assets, liabilities, equity, or net worth.”[2] This rule is rather limiting since it essentially requires that the successor entity be a “shell” company prior to acquiring the predecessor business.

The Tennessee Department of Revenue recently released a ruling that provides insight into the application of the Tennessee Carryover Exception in connection with a federal F-reorganization.[3]

Unpacking the state letter ruling

The ruling revolves around a specific taxpayer scenario involving a parent corporation (referred to as the Parent) and its U.S.-based subsidiaries, which conduct global manufacturing and distribution operations. One of these subsidiaries, referred to as the Operating Company, was a wholly owned entity performing manufacturing and distribution activities throughout the United States, including Tennessee. Due to its business activities, the Operating Company historically generated unutilized Tennessee NOL’s and tax credits (the Tennessee Tax Attributes).

The Parent sought to divest itself of certain legacy liabilities and obligations associated with the Operating Company, including insurance policies covering these liabilities. To achieve this, the Parent engaged in an internal plan of reorganization that would satisfy the requirements to be treated as a nontaxable F-reorganization under the IRC.[4] The steps of that reorganization were as follows:

1. The Parent formed of a new wholly owned subsidiary corporation (the Taxpayer) and received 10 shares of the Taxpayer’s stock (at a $10 par value) in exchange for a $100 capital contribution by the Parent to the Taxpayer.
2. The Parent contributed the stock of the Operating Company to the Taxpayer.
3. The Operating Company converted from a corporation to a single-member limited liability company (SMLLC), thereby becoming the Operating LLC.[5]

As a result of step (3), the Operating LLC became a disregarded entity for both federal and Tennessee F&E tax purposes, and all the Operating LLC’s assets and liabilities were deemed to liquidate into the Taxpayer.[6] It is also at this step that any federal tax attributes would carryover from the Operating LLC to the Taxpayer. The issue posed in this ruling is whether the Tennessee tax attributes carryover to the Taxpayer as well.

The concern is when step (3) occurs, the Taxpayer is not technically a “shell” company as required by the Tennessee Carryover Exception since it has two assets:

1. $100 it received from the Parent under step (1) and
2. Stock of the Operating Company contributed by the Parent under step (2).

Conclusion on Tennessee carryovers

The ruling concluded that Tennessee tax attributes did carryover to the Taxpayer and were available to be used by the Taxpayer against its future Tennessee F&E Tax liabilities. Even though the F-reorganization steps occurred in chronological order, the ruling recognized that they were part of one plan of reorganization and that the Taxpayer was not engaged in any operations prior to that reorganization. In addition, the assets held by the Taxpayer prior to step (3) were for the sole purpose of implementing the F-reorganization, and importantly, they were not held by the Taxpayer prior to the F-reorganization.

The bottom line

This ruling provides clarity on the utilization of Tennessee tax attributes following an F-reorganization, and how companies undergoing similar reorganizations may be able to preserve valuable tax attributes to offset future liabilities. However, taxpayers engaging in other types of transactions involving Tennessee tax attributes need to be aware of the state’s general rule limiting the carryover of those attributes and the importance of planning in order to satisfy the Tennessee Carryover Exception.

Aprio’s SALT team has experience with advising clients on the state tax impacts of corporate transactions and reorganizations. We can assist your business with structuring those transactions to minimize multistate tax liabilities and maximizing the preservation of state tax attributes. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

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[1] Tenn. Code Ann. §§ 67-4-2006(c)(2), 67-4-2009(6)(A), and 67-4-2109(e)(1).

[2] Tenn. Code Ann. §§ 67-4-2006(c)(3), 67-4-2009(6)(B), and 67-4-2109(e)(2).

[3] Tennessee Department of Revenue Letter Ruling #24-09 (Nov. 5, 2024).

[4] See IRC § 368(a)(1)(F), which defines such reorganization as “a mere change in identity, form, or place of organization of one corporation, however effected.”

[5] There were a few additional steps after the F-reorganization that were effectuated to isolate the unwanted liabilities and insurance policies for a subsequent sale.  Those steps are not relevant to this analysis.

[6] Tennessee does not generally follow the federal entity classification rules with regard to disregarded entities, except for a limited liability company whose single member is a corporation.  Tenn. Code Ann. § 67-4-2007(d) and Tenn. Comp. R. & Regs. 1320-.06.01.40.