Understanding Tennessee's F.O.N.C.E. Exemption to LLC Franchise and Excise Taxes: A Guide for Family-Owned Entities

Tennessee offers a valuable tax exemption for qualifying LLCs that are family-owned non-corporate entities (FONCE), allowing them to be exempt from the state's franchise and excise taxes. This exemption is particularly beneficial for families engaged in passive investments (like collecting residential rental income from rental properties) or farming.

Eligibility Criteria

To qualify for the FONCE exemption, an entity must meet two primary conditions:

1.     Family Ownership: At least 95% of the entity's ownership must be directly held by family members. Family members include individuals related by blood, marriage, or adoption, such as spouses, siblings, parents, children, and grandparents.

2.     Nature of Activities: At least 66.67% of the entity's activity must consist of:

o   The production of passive investment income, or

o   A combination of passive investment income and farming activities.

Passive investment income encompasses earnings from sources like residential rental income, dividends, interest, royalties, and gains from the sale of stocks or securities. It's important to note that income from commercial property rentals or active business operations does not qualify as passive investment income.

Eligible Entity Types

Only non-corporate entities can benefit from the FONCE exemption. This includes Limited Liability Companies (LLCs), Limited Partnerships (LPs), and Limited Liability Partnerships (LLPs). Corporations, including S corporations, are not eligible.

Filing Requirements

Entities seeking the FONCE exemption must submit Form FAE183, the Application for Exemption/Annual Exemption Renewal, to the Tennessee Department of Revenue. This form is due by the 15th day of the fourth month following the end of the entity's taxable period. If an entity has obtained a federal tax extension, Tennessee grants an automatic seven-month extension for this form as well. While late submissions don't disqualify an entity from the exemption, a $200 penalty may be imposed for each late filing.

The form requires a detailed disclosure of the entity's activities, including all gross receipts reported on the federal income tax return, to verify compliance with the exemption criteria.

Special Considerations

·       Multiple Properties: Owning more than four separately deeded residential properties doesn't disqualify an entity, provided each property contains no more than four rental units.

·       No Income Scenario: An entity with no income can still qualify for the exemption if it meets the ownership and activity criteria.

·       Trust Ownership: Ownership interests held indirectly through trusts may affect eligibility. Only direct ownership by family members qualifies, with the exception of testamentary trusts from deceased family members.

For a comprehensive understanding and to ensure compliance, entities should consult the Tennessee Department of Revenue's resources or seek professional tax advice. If you’d like to include the asset protection provided by LLCs and also avoid some state taxation, reach out to Vermillion Law so our experienced attorneys can help you plan for the future.