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Tennessee Lawmakers Introduce Another Reform Likely To Be Viewed As A Model For Other States To Follow

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NASHVILLE, Tenn. — Tennessee is a state where, despite boasting what is an already relatively low tax burden and no state income tax, lawmakers have continued to find new ways to improve the tax code in recent years, with reforms that provide further relief to individuals, families, and employers. New legislation recently introduced in the Tennessee General Assembly, if enacted, would grant further tax relief to Tennessee employers, particularly the most innovative businesses, and would do so in a manner that governors and lawmakers in other states are likely to emulate. 

House Bill 2144, introduced by Tennessee House Majority Leader William Lamberth (R), and its companion, Senate Bill 2397, introduced by Senate Majority Leader Jack Johnson (R), would allow companies doing business in Tennessee to continue fully deducting all research and development (R&D)-related expenses when filing their state corporate income taxes (referred to as the excise tax in Tennessee). Because of expiring provisions in the Tax Cuts & Jobs Act (TCJA), the federal tax reform bill enacted in 2017, lawmakers in Tennessee, along with their counterparts in the other states that automatically conform to the federal tax code, need to take action soon to permit businesses to continue with full R&D expensing for state taxes. HB 2144/SB 2397 is a response to that need. 

The TCJA made what are widely seen as a number of improvements to the federal tax code and provided a net tax cut to the vast majority of Americans, with IRS data showing the greatest relief going to lower- and middle-income households. One of the few downsides of the TCJA, however, was the fact that the budget reconciliation process through which the TCJA was passed required certain provisions that most Republicans wanted to make permanent, such as full R&D expensing, to expire in the out years. The extended five-year amortization period for R&D expenses that kicked in this year came about in order to make the TCJA fit into the constraints of the budget reconciliation process. Full R&D expensing is not the only temporary provision in the TCJA that Republicans would’ve made permanent had they not been handcuffed by the budget reconciliation process.

Michael Lucci, an advisor with Cicero Institute and State Policy Network, says "The federal tax code is changing each year as parts of the TCJA phase out. States need to actively choose to preserve the good parts of the TCJA in their state tax codes and cancel the bad parts. Tennessee provides a great example on how to navigate these changes to avoid a tax increase on innovation." 

Tennessee, like most states, automatically conforms to the federal tax code, meaning that the federal tax base expanding provisions in the TCJA also grew the corporate tax base in Tennessee. The end of full R&D expensing and the beginning of the five year amortization schedule that kicked in at the start of 2022 now applies to most state tax codes. By decoupling Tennessee’s tax code from the federal code’s now extended R&D amortization schedule, HB 2144/SB 2397 would allow companies and entrepreneurs doing business in Tennessee to continue to fully and immediately deduct R&D expenses when calculating their state tax liability. 

Supporters of HB 2144/SB 2397 argue that by decoupling the state tax code from the federal code’s now extended R&D amortization period, it will make Tennessee an even more attractive destination for innovation, investment, entrepreneurship, and the job creation those things facilitate. Since most states automatically conform to the federal code, states that take the initiative to decouple from the five-year federal R&D amortization schedule will have an advantage over states that do not. 

As it now stands, enacting HB 2144/SB 2397 would make Tennessee the first state to restore full R&D expensing when filing state businesses taxes. 

Not only would enactment of HB 2144/SB 2397 provide an objective financial incentive to invest and do business in Tennessee, particularly for companies in the most innovative sectors, it would also send a strong message that Tennessee is a state that promotes free enterprise and commerce by making state government less intrusive and less burdensome. Restoration of full R&D expensing at the state level would likely serve as another example where other states end up following Tennessee’s lead on tax policy. Tennessee lawmakers, for example, took action to become a true no-income-tax state by passing legislation in 2016 that phased out the state’s investment income tax, referred as the Hall Tax, by 2021. New Hampshire subsequently followed Tennessee’s lead, with Governor Chris Sununu (R) signing legislation in 2021 that will phase out the Granite State’s investment income tax, making New Hampshire the nation’s ninth true no-income-tax state. Lawmakers in Wisconsin, Mississippi, West Virginia, and other states are also now seeking to follow Tennessee’s lead with proposals to phase out their income taxes. If Tennessee lawmakers enact HB 2144/SB 2397, it will likely prove to be another instance in which other states end up taking cues from Tennessee on fiscal policy. 

Decoupling from the federal code’s five-year amortization schedule for R&D expenses would be an economically beneficial, nation-leading achievement for Tennessee lawmakers if they’re able to pass it this session. After they get that done, Tennessee lawmakers may then look to use the 2023 session to address the next decoupling need on the horizon, one that springs from another expiring TCJA provision that most congressional Republicans wanted to make permanent. 

In order to maintain full business expensing for all capital investments in Tennessee for corporate/excise tax purposes, state lawmakers will want to act starting next year. Unlike many other states that automatically conform to the federal tax code, Tennessee does not already conform to the federal code’s full business expensing. Whereas businesses operating in other states can immediately deduct capital expenditures in year one, Tennessee law requires capital expenditures to be depreciated over time, sometimes taking up to 15 years to fully deduct the cost. Governor Bill Lee and state legislators could make Tennessee and even more attractive place to do business by taking action in 2023 to provide full business expensing. 

Lucci further notes "Providing full expensing for capital assets is a key tool for both growth and a neutral tax code. And let's remember that we live in a new era of geopolitical competition. Full expensing can help incentivize capital investment and reshoring of critical production to the US."

By passing legislation to provide full expensing for capital investments in Tennessee and making it permanent, as HB 2144/SB 2397 would do for R&D expensing, Governor Lee and Tennessee legislators can give the Volunteer State another advantage over the states that currently allow full business expensing but do so through federal tax code conformity and, as such, will see full expensing start phasing out next year in accordance with the TCJA. That, however, is a bridge Tennessee legislators can cross next year. 

The more imperative need is passing HB 2144/SB 2397, which could hit Governor Lee’s desk by this spring. If it does, expect other states to follow suit with similar decoupling legislation. Lawmakers in other states are used to follow Tennessee’s lead when it comes to tax policy, so this will not be an entirely new phenomenon.

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