Historically, the taxing system was based on agriculture; but when the economy shifted from farming to manufacturing, the State abolished the property tax and replaced it with franchise and excise taxes. The excise tax is a tax that corporations pay on net profits. The current rate is 6 percent. The franchise tax is a tax that corporations pay on net worth. The current rate is 25 cents per $100 of net worth.

The new Act would eliminate the business franchise and excise taxes and replace the tax system with a 2.5 percent tax on payrolls and a 2.5 percent tax on profits, with the first $50,000 in each category to be tax exempt. There is also a discussion about placing a cap on the payroll tax. Businesses would pay taxes only on the first $300 million of its total payroll.

Coupled with the revised business tax system will be the repeal, yes the repeal, of the 6 percent sales tax on grocery food. It is also possible that the cities and the counties would elect to repeal the local sales tax on food (currently at a maximum rate of 2.75 percent), but don't hold your breath.

Why has the State decided to dramatically revise the current tax system? Because since the creation of the Limited Liability Company (LLC) and the Limited Liability Partnership (LLP) approximately 5 years ago the income from franchise and excise taxes has been decreasing at an increasing rate. For example, franchise and excise taxes for the month are down more than $20 million compared to January 1998 and are expected to erode the State's tax revenue by as much as $100 million per year.

Why is the creation of LLCs and LLPs eroding the tax revenue? Under an LLC or LLP organization all business income and losses are passed through the company untaxed at the State level and reported on the owner's federal tax return. More and more companies operating in the State are switching from a corporation organization to either an LLC or LLP. As these businesses grow and become more successful, they pay no higher taxes. One example cited was a national chain with outlets in Tennessee that reorganized to an LLC and lowered its tax liability from $1 million to $7,000. But wouldn't any smart businessperson look for a way to reduce taxes?

It has been estimated that the new business tax structure will yield approximately $1.8 billion. Some $550 million of that will go to replace the food tax and $900 million to replace the revenue lost from the repeal of the franchise and excise taxes.

The positive side of all this is that the sales tax on food would be repealed and the tax burden would be more equitably distributed among all companies operating in the State. The downside is that small businesses may experience serious financial setbacks or go out of business altogether. The other drawback is that this new tax system will be perceived as the dreaded State Income Tax.

Watch for the Governor's budget to be issued March 1, 1999, and stayed tuned for future developments that will impact us all.