NASHVILLE - A lean budget year and a tax loophole that is saving some family-owned businesses roughly $45 million could turn into the first showdown between Democratic Gov. Phil Bredesen and the new Republican majorities in the General Assembly.
Bredesen, who is contemplating layoffs of state workers to help Tennessee bridge a budget shortfall that could grow to $800 million by June, called the exemption for family-owned commercial rental properties "a fairly outrageous loophole."
State Revenue Commissioner Reagan Farr said in a budget hearing last week that his department has compiled surveys that show about 2,700 state businesses registered as family-owned noncorporate entities, or FONCEs, are shielded from paying corporate taxes on about $5 billion worth of property and $500 million in profits.
"It would be sinful to lay people off so these kinds of exemptions could be preserved," Bredesen said.
The administration tried to do away with the tax break last legislative session, but the effort ran into bipartisan opposition and ultimately was undone because it was hard to determine how many businesses would be affected.
The governor had a more direct take on what happened to the proposal. "It got mugged in the Legislature," he said.
Farr's surveys should help the administration show the tax loophole benefits relatively few of the state's about 200,000 corporate taxpayers.
Senate Republican Leader Mark Norris of Collierville said many of the concerns developed because the measure was introduced so close to the end of the session and didn't have an opportunity to go through vetting of the committee process.
"It doesn't have to be the first battleground if Commissioner Farr and others will come talk to us in advance and we can look at this carefully," Norris said. "But it's a bad time to be raising taxes on those family businesses."
Farr argued that changing the FONCEs law is not a tax increase, but "a fundamental fairness issue."
"It is imperative that two buildings sitting side by side, competing in the same marketplace, should be treated the same," he said.
It's not just Republicans who have had problems with the effort to get rid of the FONCEs exemption. Bredesen's office last week announced it had developed "trust issues" with House Majority Leader Gary Odom, a Nashville Democrat who voiced opposition to the proposal during the session last year.
"The change in that tax policy dealing with family-owned businesses was quite a surprise to me," Odom said, adding that he considered the proposal to be a "significant change in tax policies."
Jim Brown, Tennessee director for the National Federation of Independent Businesses, said his members are concerned that changes could affect small operations.
"There are a lot of mom-and-pops out there," he said. "More than 50 percent of our members have five employees or fewer - these aren't entrepreneurs investing in skyscrapers."
The Revenue Department has sent out follow-up letters to about 2,000 businesses that didn't respond to the first survey with the threat of having their exemption canceled if they don't reply.
The exemption for the 0.25 percent franchise tax on property values and 6.5 percent excise tax on income means the state is doing without $45 million it would be collecting if those businesses were not claiming an exemption.
Farr acknowledged that it would be unlikely for the state to collect the full $45 million if the law were changed because some businesses would restructure to qualify for different exemptions.
Farr also told Bredesen that some ineligible businesses like car dealerships are transferring their properties to a family-owned holding company that then turns around and charges exorbitant rents.
The commissioner said his department doesn't have the resources to launch costly investigations against companies abusing the tax exemption.
Bredesen has told some state departments that they will have to cut as much as 15 percent out of their budgets next year because of worsening economic conditions.
"It would be awful to do some of the draconian things you'd have to do in some of these departments, and at the same time be giving somebody what is clearly an abused loophole," he said.