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Tax Law

Tennessee Court of Appeals Holds Legal Malpractice Settlement Proceeds are Taxable Business Earnings

The Tennessee Court of Appeals held that a manufacturer’s proceeds from a legal malpractice action are business earnings subject to the Tennessee excise tax. The malpractice action arose when the taxpayer’s attorneys improperly filed a European patent. The damages awarded in settlement of the claim were based on profits the taxpayer would have earned if the patent had been properly filed. The court concluded that the tax classification of the settlement proceeds should be determined by looking to the nature of the right that was compromised. Because the settlement proceeds represented lost business revenue derived from the taxpayer’s intangible property – an integral part of its business – they were taxable business earnings. Also, the court determined that the taxpayer was not entitled to apportion the settlement proceeds because it conducted all of its business in Tennessee, even though it was organized in Delaware. Note that this conclusion seems to be at odds with PopularCategories.com, Inc. v. Gerregano, Dkt. No. M2017-01382-COA-R3-CV (Tenn. Ct. App. Dec. 20, 2018), in which the Tennessee Court of Appeals held that a taxpayer’s incorporation in Florida entitled it to apportion its net earnings and net worth.

Additionally, the court did not permit the taxpayer to file consolidated franchise and excise tax returns with its wholly-owned LLC subsidiaries because it is a partnership for federal tax purposes. Tennessee allows wholly-owned LLCs to file consolidated returns with their single member parents, only if the single member is a corporation.

EmeraChem Power, LLC v. Gerregano, Dkt. No. E2019-00292-COA-R3-CV (Tenn. Ct. App. June 1, 2020).