Companies that have PILOT (Payment-in-Lieu-of-Taxes) agreements in place with a local Industrial Development Board (IDB) have an additional opportunity to save tax dollars. While the main focus of a PILOT agreement is the reduction of property taxes, there are potential Tennessee franchise tax savings for certain taxpayers, dependent upon their property within the State. The savings come from elections that can be made for calculating the franchise tax base of PILOT property.
Local governments use PILOT agreements as a tool to incentivize companies considering large capital investments. The incentives come in the form of reduced property taxes. Property tax savings can provide a competitive edge in attracting companies considering multiple locations. The intent is to create jobs and stimulate economic investment within local communities that will, ultimately, increase the municipality’s long-term tax base.
The mechanics of a PILOT agreement are unusual. In a PILOT agreement, a company transfers "title" of the property to the IDB and then "leases" the property back to the company (the "lease" payment is referred to as the "PILOT" payment). Since the property is legally "owned" by the IDB, it is exempt from property taxes. The PILOT payments are generally calculated as a percentage, usually 50% or less, of what the property taxes would have been had a PILOT agreement not been in place. The PILOT payments are calculated based upon the total economic effect that the investment is expected to have on the local economy, and can last several years.
The franchise tax savings result from the structure of the arrangement. Since the company does not "own" the property (the IDB does), it can elect to exclude the book value from its franchise tax base. Instead, the taxpayer can elect to treat the PILOT payments as "rent paid" to calculate the franchise tax base of the property.
For instance, a manufacturer signs a PILOT agreement where $10M of manufacturing equipment is transferred to the IDB, with a PILOT payment of $50,000 in the first year. The company elects to use the PILOT payment to calculate the franchise tax base of the property. The PILOT payment of $50,000 is multiplied by 3; thus, the amount that is included in the Tennessee franchise tax base is $150,000. In this example, there has been a reduction of $9.85M ($10M - $150,000) in the Tennessee franchise tax base, resulting in franchise tax savings of $24,625.
Over time, the manufacturing equipment is depreciated, decreasing the book value of the equipment each year. When the book value of the property becomes less than what the calculated franchise tax base otherwise would have been using the PILOT payment, the taxpayer can make a one-time election to switch to the book value method for purposes of calculating the franchise tax base.
Over the course of a PILOT agreement the franchise tax savings can be substantial. This election should be considered by all companies that have PILOT agreements in place. The calculations are straight forward and well worth the effort.