                                                                                        06/01/2020
               IN THE COURT OF APPEALS OF TENNESSEE
                          AT KNOXVILLE
                               October 16, 2019 Session

      EMERACHEM POWER, LLC, ET AL., v. DAVID GERREGANO

                 Appeal from the Chancery Court for Knox County
                  No. 190097-1      John F. Weaver, Chancellor
                     ___________________________________

                           No. E2019-00292-COA-R3-CV
                       ___________________________________


This appeal was filed by the plaintiffs pursuant to the provisions of Tennessee Code
Annotated section 67-1-1801 to challenge assessments rendered against them by the
Commissioner of Revenue for the State of Tennessee. The dispute involves the
plaintiffs’ challenge to Tennessee’s assessments of excise tax for the period 2010 through
2012. After cross motions for summary judgment were filed, the trial court found in
favor of the Commissioner. The plaintiffs appeal. We affirm.

      Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Chancery Court
                            Affirmed; Case Remanded

JOHN W. MCCLARTY, J., delivered the opinion of the court, in which ANDY D. BENNETT
and THOMAS R. FRIERSON, II, JJ., joined.

Wayne R. Kramer and Bryce E. Fitzgerald, Knoxville, Tennessee, for the appellants,
EmeraChem Power, LLC, EmeraChem Holdings, LLC, and EmeraChem, LLC.

Herbert H. Slatery, III, Attorney General and Reporter, Andreé S. Blumstein, Solicitor
General, and Brian J. Ramming, Assistant Attorney General, Nashville, Tennessee, for
the appellee, Commissioner of Revenue for the State of Tennessee.


                                       OPINION

                                  I. BACKGROUND

       EmeraChem Power, LLC, EmeraChem Holdings, LLC, and EmeraChem, LLC,
(collectively, “the Entities”) are all limited liability companies (“LLCs”) organized and
existing under and by virtue of the laws of the State of Delaware and qualified to do
business in the State of Tennessee. The primary business offices for the Entities are
located in Knoxville, Tennessee. The Entities are affiliated, in that EmeraChem Holdings
is the sole owner and member of EmeraChem and is likewise the sole owner and member
of EmeraChem Power. Put another way, EmeraChem and EmeraChem Power are wholly
owned subsidiaries of EmeraChem Holdings, the parent company. EmeraChem Holdings
is treated as a partnership for federal tax purposes.

      EmeraChem is the operating company that does the manufacturing and selling. It
manufactures catalytic converters and other products. EmeraChem Power provides
engineering, design, and testing services. EmeraChem Holdings was created as a holding
company; it holds and manages patents and the purchase of precious metals used by
EmeraChem in the manufacturing process. The Entities were (and continue to be) leaders
in nanophase chemistry and catalysis for the control of air emissions from power
generating facilities, natural gas compression stations, and motor vehicles.

       On November 16, 2009, EmeraChem Holdings submitted a Consolidated Net
Worth Election Registration Application, which the Tennessee Department of Revenue
(“Department”) approved effective January 1, 2008. This allowed the Entities to
compute their franchise tax using consolidated net worth. However, each member of the
group was still required to compute its excise tax on a separate-entity basis and file a
separate excise tax return.

       EmeraChem Holdings filed its initial franchise-and-excise (“F&E”) return as a
consolidated return, including the net worth, assets, and income for EmeraChem Power
and EmeraChem, while EmeraChem Power and EmeraChem both filed minimum returns
reporting no net worth, assets, and no income. The Department disallowed the filing of
such initial returns on a consolidated basis asserting that it was prohibited by Tennessee
Code Annotated section 67-4-2007(d) because EmeraChem Holdings, the parent and sole
member of EmeraChem Power and EmeraChem, was a limited liability company, not a
corporation. Subsequently, the Entities each produced separate amended F&E tax returns
and delivered them to the auditors. This time, the Entities filed separate returns (rather
than a consolidated return as EmeraChem Holdings had done initially), but on the
amended returns the Entities eliminated certain intercompany transactions in computing
their excise tax liability. The Department, however, determined that the Entities had
again failed to compute their tax liabilities correctly because they were still computing
their excise tax on a consolidated basis.

       As noted, EmeraChem Holdings was created to hold and manage multiple
operating companies, patents, and the purchasing of precious metals used by EmeraChem
in the manufacturing process. The holding of patents is important and necessary for the
Entities to carry out their business and produce their products. In the tax year 2011,
EmeraChem Holdings received $1,401,689 from the settlement of a legal malpractice


                                          -2-
claim against a New York law firm.1 The funds received by EmeraChem Holdings arose
out of the legal representation by the defending law firm in connection with a particular
patent relevant to EmeraChem Holdings’ European business activity. EmeraChem
Holdings claimed that attorneys for the law firm failed to properly register Patent No.
08028252 in Europe. The fundamental basis upon which the amount of damages was
paid to EmeraChem Holdings for the New York law firm’s malpractice was lost
European revenue as a result of potential patented products or patented licensing in
Europe.

       In filing its F&E tax return for 2011, EmeraChem Holdings reported the receipt of
the legal malpractice settlement proceeds. It classified the proceeds as “non-business”
earnings for excise tax purposes and subtracted them as sourced outside of Tennessee.

       The Department conducted F&E tax audits of the Entities in 2014 for the period
January 1, 2010, through December 31, 2012. During the audit period, the Entities did
business in numerous states and foreign countries. EmeraChem had less than 50
employees. Neither EmeraChem Power nor EmeraChem Holdings had any employees
during the audit period. They all filed Tennessee F&E tax returns for the years 2010,
2011, and 2012.

       During the audit period, transfers of industrial materials2 (“Industrial Materials”)
took place between EmeraChem Holdings and EmeraChem. The transfers by
EmeraChem Holdings were not to the general public nor were the products ultimately
sold by EmeraChem to the general public or to the end user. Rather, EmeraChem
Holdings procured the Industrial Materials and then transferred them to EmeraChem for
future processing and incorporation into catalysts manufactured by EmeraChem. Title to
the Industrial Materials passed from the supplier to EmeraChem Holdings and then
passed to EmeraChem. The Industrial Materials were procured by EmeraChem
employees using EmeraChem funds. In addition, the volume, purchase price, and timing
of the purchase of the Industrial Materials were at the direction of EmeraChem, again
through its employees. EmeraChem Holdings had no employees and had no funds during
the audit period other than those provided by EmeraChem. After processing and
incorporating the Industrial Materials into the catalysts, EmeraChem would, in turn, sell
the manufactured catalysts to a third-party subcontractor or other dealer who then sold
the same to the end user (such as a power plant). Furthermore, the amount of funds
which EmeraChem Holdings received from EmeraChem (which represented more than
80% of EmeraChem Holdings’ revenue) did not include a markup and did not exceed
       1
          Receipt of the legal malpractice settlement proceeds in 2011 by EmeraChem Holdings was the
first and only time either it or any other EmeraChem entity had received proceeds of such a nature. The
total amount of malpractice proceeds paid was $2,250,000. After payment of $848,311 in attorneys’ fees,
the amount received by EmeraChem Holdings was $1,401,689.
       2
        Precious metal raw materials.
                                                 -3-
EmeraChem Holdings’ costs (including any freight, storage, and/or transportation costs).
More than 50% of EmeraChem’s revenues during the audit period were from sales of
catalysts to the subcontractors and dealers.

       As a result of the audit, the Department determined that in 2010, 2011, and 2012,
the Entities should not have computed their excise tax on a consolidated basis and should
not have filed consolidated tax returns. The Department asserted that under the
applicable statute, only a single-member LLC that is wholly owned by a corporation may
be disregarded by its parent company for excise tax purposes. EmeraChem and
EmeraChem Power are single member LLCs, but EmeraChem Holdings, their single
member, is treated as a partnership for federal income tax purposes.

       By Notice of Assessment dated May 5, 2014, EmeraChem Power was advised that
as a result of the audit conducted by the Department, it was liable for F&E tax, plus
interest and penalties. The Department claimed that EmeraChem Power was liable for
F&E tax of $1,240, a penalty of $124, and interest of $271.16, for a total amount assessed
of $1,635.16. On May 28, 2014, pursuant to Tennessee Code Annotated section 67-1-
1801(c)(3) and Tenn. Comp. R & Regs. 1320-1-2-.05(1), EmeraChem Power requested
an Informal Conference.

        By Notice of Assessment dated May 9, 2014, EmeraChem Holdings was advised
that it was liable for F&E tax of $106,601, a penalty on the F&E tax of $10,660, and
interest attributable to the F&E tax of $17,307.09. The Department further asserted that
EmeraChem Holdings was liable for County Business tax of $7,864, a penalty in
connection with the County Business tax of $1,965, and interest attributable to the
County Business tax of $1,221.80. Finally, the Department asserted that EmeraChem
Holdings was liable for City Business tax of $7,795, as well as interest thereon of
$1,207.74. The Department claimed the assessed F&E tax was due largely to the receipt
by EmeraChem Holdings of the legal malpractice settlement proceeds and the assessed
Business tax was due as a result of the transactions described above. The Department
rejected EmeraChem Holdings’ classification of the proceeds as nonbusiness earnings
and reclassified the proceeds as “business earnings” to be included as gross income for
calculation of the excise tax. Of the total excise tax assessed against EmeraChem
Holdings ($104,477), most of it ($91,109.79) represented the tax resulting from including
the settlement proceeds as part of the company’s business earnings for the 2011 tax year.
The total amount the Department claimed to be due from EmeraChem Holdings, as
reflected in the EmeraChem Holdings Notice and after applying various credits and
payments, was $154,621.63. On May 28, 2014, EmeraChem Holdings requested an
Informal Conference.

       By Notice of Assessment dated June 13, 2014, EmeraChem was advised that it
was found liable for F&E tax of $23,103.36, $2,310 in penalty, and $3,688.19 in interest
relative to the F&E tax. The Department further asserted that EmeraChem was liable for
                                         -4-
$9,760.19 in Sales & Use tax and $1,428.36 in interest resulting from the Sales & Use tax
assessment. Finally, the Department noted that EmeraChem was entitled to a County
Business tax credit of $9. Overall, as a result of the audit, the Department claimed that
the total amount due from EmeraChem to the Department, after applying various credits
and payments, was $40,281.10.3 On June 24, 2014, EmeraChem requested an Informal
Conference.

      In the auditors’ report for EmeraChem, the Department made the following
statement:

                Tennessee law makes no provision for consolidated
                franchise/excise tax returns except in the instance of a single
                member LLC whose single member is a corporation. The
                single member of EmeraChem, LLC, and EmeraChem Power,
                is not a corporation rather, it is a limited liability company
                treated as a partnership for federal tax purposes. Nor have
                any of these entities been merged out of existence.... The
                consolidation work papers provided by the Taxpayer
                demonstrates that all three entities had activity both with each
                other as well as outside the affiliated group. Tenn. Code Ann.
                § 67-4-2007(d) specifically prohibits disregarding any of
                these entities for the purpose of filing Tennessee Franchise
                and Excise Tax Returns.

When asked about Tennessee Code Annotated section 67-4-2007(d), the auditor agreed
that if EmeraChem Holdings had been a corporation instead of an LLC, “none of this
would have been a problem.” The auditor stated that if EmeraChem Holdings had been a
corporation, then reporting the income and business activity of the Entities on a
consolidated basis would have been permitted under the statute. According to the
auditor, had EmeraChem Holdings been an S Corporation and had EmeraChem Power,
EmeraChem Holdings, and EmeraChem filed their F&E tax returns for the years at issue
on a consolidated basis, the result would have been exactly the same as that reflected on
the initial F&E returns filed on behalf of the Entities.

       According to the Department, it is appropriate for EmeraChem Power,
EmeraChem Holdings, and EmeraChem to compute their net worth for franchise tax
purposes on a consolidated basis but not their income or business activity for excise tax
purposes. The Department asserted that the legal malpractice settlement proceeds of
$1,401,689 should have been included in the EmeraChem Holdings’ 2011 F&E tax return
as business earnings based upon Tennessee Code Annotated section 67-4-2004(4). In its
audits of the Entities, and specifically in the audit of EmeraChem Holdings for tax year

      3
          EmeraChem does not contest the Sales & Use tax assessment.
                                                 -5-
2011, the Department claimed that the proceeds received by EmeraChem Holdings from
the legal malpractice claim were subject to the F&E tax and must be included on the 2011
return resulting in a “tax due” of $91,109.79. In making such a claim, the Department
stated, among other things, that “the holding of patents is an integral and essential part of
the business of EmeraChem Holdings, LLC and its subsidiaries and [therefore the
malpractice proceeds] falls within the definition of “business earnings” found in Tenn.
Code Ann. §67-4-2004(4)....” As a result, the auditors (i) asserted that such proceeds
were includable in EmeraChem Holdings’ 2011 F&E tax return, (ii) disallowed the
deduction, and (iii) stated that the proceeds were subject to the F&E tax.

       After the holding of an Informal Conference pursuant to Tennessee Code
Annotated section 67-1-1801(c)(3), the Commissioner adjusted the assessments. He
issued an Adjusted Notice to EmeraChem Power, adjusting the applicable interest amount
accruing prior to the issuance of the informal conference letter, resulting in a total
adjusted amount due of $1,671.09, including excise tax in the amount of $1,240, penalty
in the amount of $124, and interest in the amount of $307.09. The Commissioner also
issued an Adjusted Notice to EmeraChem, adjusting the applicable interest amount
accruing prior to the issuance of the informal conference letter and applying a $1,035.59
credit from a previous return, resulting in a total adjusted amount due of $39,933.13,
including excise tax in the amount of $23,103, penalty in the amount of $2,310, and
interest in the amount of $4,168.87. He issued an Adjusted Notice to EmeraChem
Holdings, adjusting the applicable interest amount accruing prior to the issuance of the
informal conference letter and applying a $12,000 credit from a previous return, resulting
in a total adjusted amount due of $143,328.77, including excise tax in the amount of
$104,477, business tax in the amount of $15,659, penalties in the amount of $12,625, and
interest in the amount of $22,567.77. The overall total amount the Department claimed
was $184,932.99 as of June 15, 2015.4




        4
           EmeraChem paid the adjusted Sales and Use tax assessed against it ($9,760.19), plus applicable
interest; thus, EmeraChem’s Sales and Use tax Assessment is not at issue in this suit.
                                                  -6-
       The Entities filed suit in August 2015. The case was heard on cross-motions for
summary judgment. In a final judgment entered on January 18, 2019, the trial court
upheld the excise tax assessments, upheld the penalties against EmeraChem and
EmeraChem Power, and upheld the penalty against EmeraChem Holdings except for the
portion attributable to the malpractice settlement proceeds ($9,110.97).

        The trial court agreed with the Commissioner that EmeraChem Holdings’
malpractice settlement proceeds were business earnings subject to Tennessee excise tax.
It determined that the proceeds represented lost revenues related to the company’s
patents, which, if they had not been lost because of the malpractice of the New York law
firm, would have been taxable as business earnings. The court also found no basis upon
which to allow EmeraChem Holdings to apportion any of the proceeds to New York or
elsewhere because it had failed to demonstrate a presence or business activities in New
York. The Entities failed to show any business activities that were taxable both inside
and outside Tennessee. The trial court further determined that the Entities were not
entitled to file consolidated excise tax returns or compute their excise tax on a
consolidated basis. The court rejected the Entities’ constitutional challenge to section 67-
4-2007(d), finding that they had failed to prove an equal-protection violation and that the
Commissioner had demonstrated a rational basis for the statute’s different treatment of
corporations and LLCs. Finally, the court upheld the negligence penalties imposed by
the Commissioner with respect to the consolidated tax returns because the Entities had
been given prior warnings against the filing of consolidated returns.5 The Entities filed
this timely appeal.


                                             II. ISSUES

        We restate the issues raised in this appeal as follows:

                1. Whether the Entities were properly assessed additional
                excise tax for the years 2010 to 2012 because EmeraChem
                Holdings filed consolidated excise-tax returns on behalf of
                itself and EmeraChem and EmeraChem Power, instead of the
                Entities filing separate returns under Tennessee Code
                Annotated section 67-4-2007(d).

                2.    Whether Tennessee Code Annotated section 67-4-
                2007(d)’s requirement for the filing of separate returns is
                constitutional because there is a rational basis for excepting

        5
         The court observed that the Commissioner had withdrawn the claim for the business tax
assessment. The amounts related to that issue are $15,659 in business tax, $1,965 in penalty, and interest
of $2,870.91.
                                                  -7-
              LLC’s whose single member is a corporation.

              3. Whether the proceeds received by EmeraChem Holdings in
              2011 from the settlement of a legal-malpractice claim were
              properly subject to Tennessee excise tax because they were
              “business earnings.”

              4. Whether the Entities were properly assessed negligence
              penalties for failing to file separate returns under Tennessee
              Code Annotated section 67-4-2007(d), when the Entities had
              prior notice of that requirement.


                            III. STANDARD OF REVIEW

       This case was decided by summary judgment. Summary judgment is appropriate
when “the pleadings, depositions, answers to interrogatories, and admissions on file,
together with the affidavits, if any, show that there is no genuine issue as to any material
fact and that the moving party is entitled to a judgment as a matter of law.” Tenn. R. Civ.
P. 56.04. We review a trial court’s ruling on a motion for summary judgment de novo,
without a presumption of correctness. Rye v. Women’s Care Center of Memphis,
MPLLC, 477 S.W.3d 235, 250 (Tenn. 2015); Dick Broad. Co., Inc. of Tenn. v. Oak Ridge
FM, Inc., 395 S.W.3d 653, 671 (Tenn. 2013). In doing so, we make a fresh
determination of whether the requirements of Rule 56 of the Tennessee Rules of Civil
Procedure have been satisfied. Rye, 477 S.W.3d at 250 (citing Estate of Brown, 402
S.W.3d 193, 198 (Tenn. 2013); Hughes v. New Life Dev. Corp., 387 S.W.3d 453, 471
(Tenn. 2012)).

       To the extent that the issues raised in this appeal require us to interpret and apply
statutes, we note that statutory interpretation is a question of law, which we review de
novo, affording no presumption of correctness to the conclusions of the trial court. State
v. Crank, 468 S.W.3d 15, 21 (Tenn. 2015); In re Baby, 447 S.W.3d 807, 817 (Tenn.
2014); Mansell v. Bridgestone Firestone N. Am. Tire, LLC, 417 S.W.3d 393, 399 (Tenn.
2013) (citing Waters v. Farr, 291 S.W.3d 873, 882 (Tenn. 2009)). The principles of
statutory interpretation are well established. When reading “statutory language that is
clear and unambiguous, we must apply its plain meaning in its normal and accepted use,
without a forced interpretation that would limit or expand the statute’s application.”
Eastman Chemical Co. v. Johnson, 151 S.W.3d 503, 507 (Tenn. 2004).

       “[W]e presume that every word in a statute has meaning and purpose and should
be given full effect if the obvious intention of the General Assembly is not violated by so
doing.” SunTrust Bank v. Burke, 491 S.W.3d 693, 695 (Tenn. Ct. App. 2015), perm. app.
denied (Tenn. June 15, 2015) (quoting Lind v. Beaman Dodge, 356 S.W.3d 889, 895
                                             -8-
(Tenn. 2011)). “When a statute is clear, we apply the plain meaning without
complicating the task.” In re Baby, 447 S.W.3d 807, 817 (Tenn. 2014). However, when
a statute is ambiguous, “we may reference the broader statutory scheme, the history of the
legislation, or other sources.” Colonial Pipeline Co. v. Morgan, 263 S.W.3d 827, 836
(Tenn. 2008).

       Courts must liberally construe statutes that impose a tax in favor of the taxpayer
and strictly construe them against the taxing authority. Eastman Chemical, 151 S.W.3d
at 507. “[W]here there is doubt as to the meaning of a taxing statute, the doubt must be
resolved in favor of the tax payer.” Commercial Standard Ins. Co. v. Hixson, 133 S.W.2d
493, 494 (Tenn. 1939). This construction, however, must be fair and give effect to the
language of the statute. See, e.g., International Harvester Co. v. Carr, 466 S.W.2d 207,
214 (Tenn. 1971); United Inter-Mountain Tel. Co. v. Moyer, 426 S.W.2d 177, 181 (Tenn.
1968).


                                        IV. DISCUSSION

                                      Additional Excise Tax

        Under Tennessee law, neither EmeraChem nor EmeraChem Power are permitted
to file consolidated F&E tax returns with EmeraChem Holdings, their parent company,
because EmeraChem Holdings is treated as a partnership for federal tax purposes.6 The
language of Tennessee Code Annotated section 67-4-2007(d) makes the separate filing
requirement clear:

               For purposes of the excise tax levied by this part, a business
               entity shall be classified as a corporation, partnership, or other
               type business entity, consistent with the way the entity is
               classified for federal income tax purposes, and subject to tax
               in accordance with this part. Notwithstanding any law to the
               contrary, entities that are disregarded for federal income tax
               purposes, except for limited liability companies whose single
               member is a corporation, shall not be disregarded for
               Tennessee excise tax purposes.

Tenn. Code Ann. § 67-4-2007(d).



       6
         Under the federal “check-the-box” tax scheme, LLCs with 2 or more members (owners) are
treated as partnerships by default. If an LLC wishes to be treated as a corporation, they may elect such
treatment so long as they are an eligible entity under 26 C.F.R. § 301.7701-3(a).
                                                 -9-
       For Tennessee F&E tax purposes, businesses are classified according to their
federal income tax classification. Id. Under the general rule, businesses classified as
disregarded entities for federal income tax purposes will not be disregarded for Tennessee
F&E tax purposes. Id. Since Tennessee is a separate reporting state for excise-tax
purposes, business entities must calculate their excise-tax liability separate from any
parent company or affiliate, and they must file their own separate return.

       The legislature created one exception to the general rule, and that exception only
applies to business entities that are: (1) single-member LLCs, (2) classified as
disregarded entities under the federal income tax system, and (3) their single-member
parent is a corporation. If a business entity meets all three requirements, it is disregarded
for Tennessee F&E tax purposes. This exception is the only instance in which a business
entity may file a consolidated excise-tax return with its parent company.

      Tenn. Comp. R. & Regs. 1320-06-01-.40 further clarifies the language in
Tennessee Code Annotated section 67-4-2007(d):

        (1) Disregarded Limited Liability Companies. A limited liability
        company is disregarded for franchise and excise tax purposes only if it is
        disregarded for federal income purposes and its single member is classified
        as a corporation for federal income tax purposes. If a limited liability
        company does not meet both of these requirements, it will be treated
        separately for franchise and excise tax purposes and must file its own
        separate franchise and excise tax return.

        (2) Other Federally Disregarded Entities. Only a limited liability
        company meeting the requirements of (1) will be disregarded for franchise
        and excise tax purposes. All other taxpayers subject to the franchise or
        excise tax will be treated separately, regardless of whether they are
        otherwise disregarded for federal income tax purposes.

Tenn. Comp. R. & Regs. 1320-06-01-.40. The regulation repeats the plain language of
Tennessee Code Annotated section 67-4-2007(d) and explains that the parent company’s
federal income tax classification determines whether the subsidiary LLC will be
disregarded for Tennessee F&E tax purposes. The exception to the general rule applies
to LLCs “whose single member is a corporation,” but the “corporation” requirement is
satisfied when “the single member is classified as a corporation for federal income tax
purposes.” Tenn. Code Ann. § 67-4-2007(d). Therefore, non-corporate parents satisfy the
corporation requirement so long as the non-corporate parent is classified as a corporation
for federal income tax purposes.7

        7
          For example, a subsidiary whose single-member/parent is an LLC will fall within the exception
to the general rule if the parent LLC is classified as a corporation for federal tax purposes. This result is
                                                   - 10 -
       EmeraChem and EmeraChem Power are not disregarded entities for Tennessee
F&E tax purposes because neither fall within the exception to the general rule set out in
Tennessee Code Annotated section 67-4-2007(d).             Although EmeraChem and
EmeraChem Power are single-member LLCs and disregarded entities under the federal
income tax system, their parent–EmeraChem Holdings–is classified as a partnership for
federal income tax purposes. Since EmeraChem Holdings is not classified as a
corporation, EmeraChem and EmeraChem Power are not disregarded entities for
Tennessee F&E tax purposes. Accordingly, EmeraChem and EmeraChem Power must
calculate their own separate excise-tax liability and file their own separate returns.
“Doing business in Tennessee by any person or taxpayer . . . is declared to be a taxable
privilege.” Tenn. Code Ann. § 67-4-2005. The Entities must conform to the laws of
Tennessee, and they cannot compute their excise tax on a consolidated basis or file
consolidated excise-tax returns with their parent, EmeraChem Holdings.


                                           Constitutionality

       We affirm the trial court’s determination that Tennessee Code Annotated section
67-4-2007(d) is constitutionally valid under both the United States Constitution and the
Tennessee Constitution. Rational basis scrutiny is the appropriate level of equal
protection review in this case. Dr. Pepper Pepsi-Cola Bottling Co. of Dyersberg, LLC v.
Farr, 393 S.W.3d 201, 209 (Tenn. Ct. App. 2011). “If any possible reason can be
conceived to justify the classification, or if the reasonableness be fairly debatable, then
the legislation will not be struck down.” Id. at 210. It is well settled that the appellant
bears the burden in proving that a tax statute is unconstitutional and must meet this
burden by establishing that either: (1) the state’s objective is not legitimate, or (2) the
statutory classification does not rationally advance a legitimate state objective.
Nolichucky Sand Co. v. Huddleston, 896 S.W. 2d 782, 788 (Tenn. Ct. App. 1994); see
also Admiralty Suites and Inns v. Shelby County, 138 S.W.3d 233, 240 (Tenn. Ct. App.
2003). In this case, the Entities have failed to meet their burden for the reasons addressed
below.

                                                     1.

       Tennessee Code Annotated section 67-4-2007(d) has a rational basis because it
captures business earnings that are subject to the Tennessee F&E tax and which may
otherwise go unreported (or be under-reported) by certain parent companies.

       In Tennessee, for F&E tax purposes, the starting point in determining a business
entity’s tax classification is its federal tax return and federal tax classification. Newell

proper despite the fact that an LLC is not a corporation.
                                                   - 11 -
Window Furnishing, Inc. v. Johnson, 311 S.W.3d 441, 455 (Tenn. Ct. App. 2008).
Analyzing the purpose of Tennessee Code Annotated section 67-4-2007(d) requires an
understanding of how the federal government taxes different business entities based on
their status as a corporation, partnership, or disregarded entity.

       Subchapter C of the Internal Revenue Code applies to businesses organized as
corporations. Corporate profits are subject to double taxation because corporations must
report their earnings, file federal tax returns with the Internal Revenue Service, and pay
taxes. When a corporation distributes corporate profits to its shareholders, the
shareholders must report the amount they receive and pay the corresponding taxes.8
Thus, the corporate profits are reported and taxed twice: once at the corporate level, and
once by the individual shareholders.

       Subchapter K of the Internal Revenue Code applies to partnerships. Unlike
corporations, partnerships do not file federal tax returns at the entity level or pay taxes on
partnership profits. Instead, a partnership simply tracks its profits and losses and, at the
end of its tax year, allocates the total profit or loss to the individual partners based on the
partnership agreement. The individual partners, rather than the partnership, are
responsible for reporting the partnership’s earnings and paying the corresponding taxes.
The Internal Revenue Code labels this style of taxation as “pass-thru” because business
earnings pass through the business entity without being taxed. Sole proprietorships and
single-member LLCs, both of which are classified as disregarded entities by default, also
have the benefit of pass-thru taxation. On the whole, this pass-thru system can make it
more difficult to administer certain tax laws and trace business income.

        LLCs are a hybrid business entity, and–unlike corporations or partnerships–the
Internal Revenue Code does not contain a specific subchapter addressing LLC taxation.
Instead, LLCs are given considerable flexibility and may be categorized as corporations,
partnerships, or disregarded entities. Under the default rules, LLCs with a single-
member–such as EmeraChem and EmeraChem Power–are classified as disregarded
entities, and LLCs with more than one owner–such as EmeraChem Holdings–are
classified as partnerships for federal income tax purposes. In both scenarios, the LLCs
are pass-thru entities that do not file federal tax returns.9

      In this case, both EmeraChem and EmeraChem Power are disregarded entities.
Both companies generate income, and the profits are passed through to their mutual

        8
          The amount the taxpayer reports/pays varies considerably and typically depends on whether the
distribution is a dividend, non-liquidating distribution, or liquidating distribution.
        9
          LLCs do have the ability to opt-in to subchapter C tax treatment in lieu of the default rules. If an
LLC makes this election, the business entity must file a federal tax return with the IRS and pay any
corresponding taxes. As with corporations, the LLCs profits will be taxed a second time when they
distribute those profits to their individual members.
                                                   - 12 -
parent company–EmeraChem Holdings–without being taxed.                 Since EmeraChem
Holdings is classified as a partnership for federal tax purposes, its profits (including the
income it receives from EmeraChem and EmeraChem Power) are passed through to its
individual members/owners without being taxed. When EmeraChem Holdings allocates
profits to its members, the individual members are the only parties responsible for
reporting the profits and paying taxes.

       The Entities’ business structure illustrates why Tennessee does not follow federal
tax classification or allow single-member LLCs to automatically retain their disregarded
entity status. A series of pass-thru business entities, none of which file federal tax
returns, increases the risk that taxpayers will under-report earnings that are subject to the
Tennessee F&E tax. Further, following the federal system would make administration of
the tax laws more difficult. As argued by the Commissioner:

       Tenn. Code Ann. § 67-4-2007(d) reaches earnings that might otherwise be
       lost if they were allowed to be passed through to a nontaxable parent.
       Because Tennessee excise tax law is tied initially to federal tax returns, if
       the federal rule were followed, single-member LLCs could pass their
       earnings through to a partnership that is not subject to Tennessee excise tax.
       And because an LLC that is [treated as] a partnership [for federal income
       tax purposes] does not report its income for federal purposes at all there
       would be no way that the Commissioner could know, much less tax, the
       income. There is the very real possibility that the disregarded LLC’s
       earnings, and the resulting Tennessee excise tax, could be altogether
       avoided by the nontaxable parent. It is certainly reasonable for the State to
       seek to recover excise tax from a business based on its Tennessee earnings,
       and the statute accomplishes this goal.

        The State’s objective is to reduce the risk of under-reporting and hold business
entities increasingly accountable for reporting their business earnings. This objective is
undoubtedly legitimate, and the federal government frequently enacts proactive tax
regulations to reduce the risk of under-reporting. Tennessee Code Annotated section 67-
4-2007 rationally advances the state’s legitimate objective because it decreases the
number of LLCs classified as disregarded entities and thereby increases the overall
number of businesses that must file separate tax returns for Tennessee F&E tax purposes.
This structure increases transparency and reduces the overall risk of abuse or
underreporting.




                                           - 13 -
                                                        2.

       Section 67-4-2007(d) rationally advances the state’s legitimate objective despite
the fact that the statute fails to capture income that may otherwise go unreported by S
corporations.

        The Entities bear the burden of proving that the statute is unconstitutional. Since
the state’s purpose is legitimate, the constitutional challenge fails unless the Entities
demonstrate that the statutory classification in Tennessee Code Annotated section 67-4-
2007 is irrational or arbitrary. Nolichucky Sand Co., 896 S.W. 2d at 788. A state is free
to categorize entities, and in doing so, the grouping may result in a law that is either
under-inclusive or overinclusive. CALVIN MASSEY & BRANNON P. DENNING, AMERICAN
CONSTITUTIONAL LAW: POWERS AND LIBERTIES 639 (6th ed. 2019). “A law is enacted to
achieve a legislative objective, but the classification employed by the law may not
perfectly achieve that objective.” Id. at 637. “A statutory classification is said to be
under-inclusive when it includes (or excludes) fewer people or things than necessary to
perfectly achieve the objective.” Id. at 638. However, the under-inclusive or over-
inclusive nature of a statutory classification rarely renders the statute arbitrary or
irrational. Id.

       Although the statutory classification in section 67-4-2007(d) helps achieve the
State’s legitimate purpose, the Entities have demonstrated that the language of the statute
may fail to capture income from one type of pass-thru parent company: S corporations.10
S corporations are unique because they are classified as corporations for federal tax
purposes, but they have the benefit of pass-thru taxation and allocate their earnings to
shareholders in the same manner that partnerships pass their earnings to partners.11 See
I.R.C. §1363(b) (2019). The Entities are correct in their assertion that LLCs whose
single-member is an S corporation receive preferential treatment under Tennessee Code
Annotated section 67-4-2007(d) despite the pass-thru nature of the S corporation parent:

                S corporations are corporations that elect to pass corporate
                income, losses, deductions, and credits through to their
                shareholders for federal tax purposes. Shareholders of S

        10
          S corporations are typically much smaller than C corporations. In order to become an S
corporation, the corporation must submit Form 2553 Election by a Small Business Corporation and meet
several requirements. Subchapter S of the Internal Revenue Code provides guidelines and rules for S
corporations in addition to the rules set out in Subchapter C.
        11
          Every business has owner(s), but the title of the owner(s) depends on the type of business entity.
Partnerships pass their income to partners, LLCs pass their income to the members of the LLC, and S
corporations pass their income to corporation’s shareholders. When an LLC or S corporation is classified
as a partnership for tax purposes, the members or shareholders should retain the title associated with their
ownership rather than being referred to as partners.
                                                  - 14 -
              corporations report the flow-through of income and losses on
              their personal tax returns and are assessed tax at their
              individual income tax rates. This allows S corporations to
              avoid double taxation on the corporate income.12


        Income passes through S corporation parent companies in the exact same manner
that it passes through other types of pass-thru parents companies, but an S corporation’s
subsidiary may nonetheless fall within the exception to the general rule in Tennessee
Code Annotated 67-4-2007(d). Since S corporations are still classified as corporations
for federal income tax purposes, LLCs whose single-member parent is an S corporation
will retain their status as a disregarded entity and have the benefit of filing consolidated
excise-tax returns with their pass-thru parent company. The Entities argue that the
statutory classification in Tennessee Code Annotated section 67-4-2007(d), and its
inclusion of S corporation parents in the exception to the general rule, renders the statute
irrational and arbitrary.

       The Entities are correct that Tennessee Code Annotated 67-4-2007(d) would be
even more effective if the exception to the general rule was limited to LLCs whose
single-member parent is a C corporation rather than all corporations in general. If the
language excluded S corporation parents, then fewer LLCs would retain their disregarded
entity status. Such change would increase the number of business entities that are
required to file their own returns and calculate their own separate excise-tax liability.
This may increase transparency and further reduce the risk of under-reporting, but such
change must be made by the legislature, not the judiciary.

        If the purpose of Tennessee Code Annotated 67-4-2007(d) is to track business
income that could be under-reported by pass-thru parent companies, then the statutory
classification seems ineffective when it is applied to LLCs whose single-member parent
is an S corporation. Treating S corporations like regular corporations seems to
undermine the purpose of the statute because S corporations, like other pass-thru entities,
appear equally likely to engage in underreporting. However, this reasoning is unsound.
Unlike other pass-thru entities, S corporations must file informational tax returns with the
Internal Revenue Service. RICHARD L. DOERNBERG, FEDERAL INCOME TAXATION OF
CORPORATIONS AND PARTNERSHIPS 523 (5th ed. 2014). This reduces the risk that S
corporations will engage in abusive under-reporting because the Commissioner can trace
an S corporation’s income by obtaining the informational filing. Overall, there is more
transparency and less difficulty administering tax laws when a pass-thru parent is an S
corporation. This helps explain why the Tennessee legislature gives LLCs whose single-


       12
          Internal Revenue Service, S Corporations, DEPARTMENT OF TREASURY (Apr. 08, 2020),
https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations
                                           - 15 -
member parent is an S corporation preferential treatment as compared to LLCs with other
types of pass-thru parents.

        The Entities failed to establish that the statute is unconstitutional. The statutory
classification has a rational basis because it captures a significant portion of income that
is difficult for the Commissioner to track. Furthermore, the exception to the general rule
does not undermine section 67-4-2007(d)’s legitimate purpose because S corporations are
less likely to engage in abusive underreporting.


                                                   3.

       Tennessee Code Annotated section 67-4-2007(d)’s preferential treatment of
subsidiary LLCs whose single-member parent is an S-corporation does not violate the
Equal Protection Clause.

       The Entities’ equal protection argument is based on the fact that Tennessee Code
Annotated section 67-4-2007(d) treats two similarly situated business entities differently:
subsidiary LLCs whose single-member parent is an S corporation, and subsidiary LLCs
whose single-member parent is an LLC that is classified as a partnership for federal
income tax purposes. In both scenarios, the subsidiary LLCs are pass-thru entities with
pass-thru parents. Although they are similarly situated for federal tax purposes,
Tennessee distinguishes between the subsidiary LLCs based on whether their single-
member parent is classified as a corporation for federal income tax purposes.13

        Both the United States Constitution and the Tennessee Constitution contain an
Equal Protection Clause that guarantees, “all persons similarly circumstanced shall be
treated alike.” State v. Robinson, 29 S.W.3d 476, 480 (Tenn. 2000). However, “it is well
settled that the equal protection clause does not require absolute equality from the State.”
Posey v. City of Memphis, 164 S.W.3d 575, 578-79 (Tenn. Ct. App. 2004) (citing to
Gray’s Disposal Co. v. Metro Gov’t of Nashville, 122 S.W. 3d 148, 162-63 (2002).
“Legislative classifications are presumed to be valid unless there is some reason to be
suspicious of the classifying device or its effect.” CALVIN MASSEY & BRANNON P.
DENNING, AMERICAN CONSTITUTIONAL LAW: POWERS AND LIBERTIES 639 (6th ed.
2019). Any statutory classification related to the application of certain tax laws
necessarily divides people into two classes, but that is not enough to invalidate the law as
violative of the equal protection clause. Id at 638. Statutory classifications are not in

        13
          The differential treatment begins at the federal level because the Internal Revenue Service
categorizes S corporations as corporations for federal income tax purposes despite the fact that they are
pass-through entities. If the Internal Revenue Service classified S corporations as partnerships (their
function equivalent), then the statutory classification in Tennessee Code Annotated section 67-4-2007(d)
would not give rise to unequal treatment.
                                                 - 16 -
themselves improper, and the legislature is not required to treat all businesses the exact
same. Christ Church Pentecostal v. Tenn. State Bd. of Equalization, 428 S.W.3d 800,
822 (Tenn. Ct. App. 2013) (citing Plyler v. Doe, 457 U.S. 202, 216 (1982)). Further, the
legislature is allowed considerable latitude in establishing categorical classifications. Id.

        Here, the Entities failed to overcome the presumption that Tennessee Code
Annotated section 67-4-2007(d) is valid. The unequal treatment of two business
structures does not equate to unlawful discrimination in violation of the Equal Protection
Clause in the 14th Amendment to the United States Constitution or Article XI, Section 8
of the Tennessee Constitution. A statutory classification based on a business’s structure
and the federal tax classification of their parent company is not inherently suspicious.
The Tennessee legislature is allowed considerable latitude in establishing categorical
classifications, and the federal filing requirement associated with S corporations justifies
the differential and preferential treatment of subsidiary LLCs whose single-member pass-
thru parent is an S corporation.

       Business entities are free to organize their enterprise in a manner that affords them
the benefit of consolidated filing for federal income tax purposes and Tennessee F&E tax
purposes. It would be improper to construe Tennessee Code Annotated section 67-4-
2007(d) as violating Equal Protection since business entities are ultimately responsible
for determining how the statute affects their filing status. If the Entities wanted to file
consolidated tax returns, they should have read the Tennessee laws and structured their
enterprise accordingly. Even after EmeraChem Holdings was formed, the LLC could
have elected to be classified as a corporation for federal tax purposes so that the Entities
could have the benefit of consolidated filing. The Entities did not make such election,
and they should not expect special treatment.


                                        Business Earnings

        An issue before us is whether the proceeds from a legal malpractice action should
be categorized as business earnings subject to the Tennessee excise tax. The damages
from the malpractice action arose when EmeraChem Holdings’ New York attorneys
improperly filed a European patent. Although the European patent filing was
unsuccessful, the damages awarded in settlement of the malpractice claim were
nonetheless based on profits that would have been earned if the patent had been properly
filed.14 We agree with the Commissioner and affirm the trial court’s holding that the tax
classification of the settlement proceeds should be determined by looking to the nature
and basis of the settled action, with those settlement proceeds having the same nature as

       14
          EmeraChem Holdings stipulated that the damages paid in its legal malpractice action
represented lost revenues from potential patented products or patent licensing in Europe (The
fundamental basis upon which the amount of damages was paid . . . was lost European Revenue.”).
                                            - 17 -
the right that was compromised. See Freda v. Comm’r, 656 F.3d 570, 573-577 (7th Cir.
2011).


                                             1.

       Any income that falls within Tennessee’s statutory definition of business earnings
will be subject to the Tennessee Excise tax. “Business earnings” under Tennessee Code
Annotated section 67-4-2004 are:

              Earnings arising from transactions and activity in the regular
              course of the taxpayer’s trade or business or earnings from
              tangible and intangible property, if the acquisition, use,
              management or disposition of the property constitutes an
              integral part of the taxpayer’s regular trade or business
              operations. In essence, earnings that arise from the conduct of
              the trade or trades or business operations of a taxpayer are
              “business earnings,” and the taxpayer must show by clear and
              cogent evidence that particular earnings are classifiable as
              nonbusiness earnings. A taxpayer may have more than one (1)
              regular trade or business in determining whether income is
              “business earnings.”

Tenn. Code Ann § 67-4-2004(4).

       In examining the definition of business earnings under Tennessee Code Annotated
section 67-4-2004(4), two tests have been identified. The section of the statute defining
“business earnings” as “[e]arnings arising from transactions and activity in the regular
course of the taxpayer’s trade or business” has been referred to as the “transactional test,”
whereas earnings “from tangible and intangible property, if the acquisition, use,
management or disposition of the property constitutes an integral part of the taxpayer’s
regular trade or business operations” has been called the “functional test.” See Newell
Window Furnishing, 311 S.W.3d at 446-47.

        Relevant here is the functional test, business earnings that, “arise from either the
management, use, acquisition, or disposition of property that constitutes an integral part
of the taxpayer’s trade or business.” Id. at 447. The phrase, “acquisition, use,
management or disposition of the property,” has been interpreted to mean that, “the
taxpayer must control, but not necessarily own, the property in order for the earnings
arising from that property to qualify as business earnings.” Blue Bell Creameries v.
Roberts, 333 S.W.3d 59, 65 (Tenn. 2011). If the property is incidental or unrelated to the
taxpayer’s business operations, earnings from that property will not fall within the
definition of business earnings. Id. Earnings from the disposition of intangible property
                                           - 18 -
are properly classified as business earnings subject to the Tennessee excise tax if the
intangible property was an integral part of the taxpayer’s business. Id. In determining
whether the property was an integral part of the taxpayer’s business, courts determine
whether the property itself was an integral part of the corporation’s regular business, not
whether the act of selling that property is an integral part of the corporation’s business.
Id.

       The issue of classifying malpractice settlement proceeds for tax purpose has been
settled in other courts, and those opinions are instructive for determining whether
EmeraChem Holdings’ settlement proceeds should be categorized as business earnings.
The Seventh Circuit held that, for purposes of determining the tax classification of
settlement proceeds, “the amounts received in compromise of a claim must be considered
as having the same nature as the right compromised.” Freda, 656 F.3d at 573-574. The
court must assess the nature and basis of the action settled. Id. If the settlement proceeds
represent damages for lost profits or earnings, then those proceeds should be classified as
business earnings and taxed as if they had been earned in the regular course of business.
Id.

       EmeraChem Holdings argues that the underlying basis of the settlement was legal
malpractice, and the settlement proceeds were paid in consideration of EmeraChem
Holdings giving up its right to move forward with its lawsuit. However, EmeraChem
Holdings stipulated that the settlement amount was calculated based on lost revenues
from potential patented products or patent licensing in Europe. Thus, the settlement
payment EmeraChem Holdings received in compromise of its claim actually represents
two rights: (1) the right to receive income that would have been generated from the
European patents, and (2) the right to move forward in its malpractice lawsuit. If the
attorneys had not committed malpractice by improperly filing the European patents, the
revenue generated by those patents would have been taxable as business earnings.
Overall, the nature and basis of the settled action is akin to a business transaction in
which EmeraChem Holdings was compensated for lost business earnings. Since the
amount received in settlement takes on the same nature as the right that was
compromised, the earnings that represent lost business revenue must be categorized as
business earnings for Tennessee excise-tax purposes. Freda, 656 F.3d at 573-574.

       Under the functional test, the settlement proceeds are business earnings because
they arose from EmeraChem Holdings’ management, use, or acquisition of its U.S.
patents, all of which is controlled exclusively from the office in Tennessee. Furthermore,
the patents are an integral part of EmeraChem Holdings’ business, and holding patents is
neither incidental or unrelated to EmeraChem Holdings’ business operations.15 In light
of the foregoing, the trial court and Commissioner properly classified the settlement

       15
          EmeraChem Holdings owns approximately seventeen U.S. patents, most of which are also
registered abroad.
                                            - 19 -
payment as business earnings.

       EmeraChem Holdings argues that, if the settlement proceeds are indeed business
earnings, they should be apportioned because EmeraChem Holdings does business in
numerous states and in Europe. Specifically, EmeraChem Holdings wants the proceeds
to be apportioned based on the business it conducts in New York. The Commissioner
apportioned the entire amount of settlement proceeds to Tennessee based on their finding
that EmeraChem Holdings had no nexus of business elsewhere:

             EmeraChem Holdings had no employees, property, activities,
             operations, offices, or other facilities in New York,
             California, or elsewhere. Indeed, the only activities in which
             EmeraChem Holdings is engaged are conducted from its
             office in Knoxville, Tennessee. The company performs only
             two functions: (1) holding and managing patents, and (2)
             purchasing precious metals in or order to immediately sell
             them to EmeraChem, which is also located only in Tennessee.
             Even the malpractice claim against the New York law firm
             was handled by Tennessee attorneys and the settlement
             agreement specifically states that it was made “in accordance
             with the law of the State of Tennessee” and can be enforced
             only in Tennessee. EmeraChem Holdings’ connections to
             Tennessee are extensive and exclusive. No operations are
             conducted elsewhere.

(Internal citations omitted). The trial court agreed with the Commissioner and concluded
that the record did not support the assertion that EmeraChem Holdings was entitled to
apportionment.

       Apportionment applies to business earnings and it is intended to obtain a rough
approximation of the corporate income that is related to activities conducted in the taxing
state. Blue Bell Creameries, 333 S.W.3d at 65. The taxpayer, EmeraChem Holdings, has
the burden of establishing that it is entitled to apportionment. Navarre Corp. v. Tidwell,
524 S.W.2d 647, 649 (Tenn. 1975).

       Reviewing the record, EmeraChem Holdings failed to establish that it is entitled to
apportionment. All of EmeraChem Holdings’ business is conducted in Tennessee.
EmeraChem Holdings asserted that it held some precious metals in New York or
California accounts, but it did not hold the title to those materials. When EmeraChem
Holdings purchased precious metals from their seller, it would immediately sell the
precious metals to EmeraChem and simultaneously transfer title to EmeraChem. Further,
the fact that EmeraChem Holdings does not have employees, property, operations,
offices, or facilities anywhere other than Tennessee indicates that it has no nexus of
                                          - 20 -
business elsewhere.   Accordingly, we affirm the trial court’s finding that the
Commissioner’s decision to apportion the entire amount of settlement proceeds to
Tennessee was proper.


                                       Negligence Penalties

       The Commissioner assessed a 10% negligence penalty on the excise tax due from
each entity. The trial court determined that: (1) the penalty was properly assessed with
respect to the excise tax attributable to the consolidated reporting, but (2) the penalty was
not properly assessed with respect to the malpractice settlement proceeds. See Tenn.
Code Ann. § 67-1-804(b)(5). We affirm the trial court’s finding.

        The portion of negligence penalties attributable to the Entities’ consolidated filing
was properly assessed. Tennessee Code Annotated section 67-4-2007(d) plainly states
that a subsidiary LLC cannot be a disregarded entity unless its single-member parent is
classified as a corporation for federal income tax purposes. Further, the Commissioner
issued a general notice that a single-member LLC will not be disregarded for F&E tax
purposes if its single-member is not classified as a corporation for federal tax purposes.
See Tennessee Important Notice No.13-16, issued November 1, 2013.16

       The Entities received specific warnings against the filing of the consolidated tax
return. Before the assessments in this case, EmeraChem Holdings also received a F&E
tax assessment for 2008 and consequently participated in an informal conference with the
Department. Afterward, the Department issued its informal conference decision, and
stated that EmeraChem was not a disregarded entity because its single-member,
EmeraChem Holdings, is an LLC that is treated as a partnership for federal income tax
purposes, not a corporation for federal income tax purposes, and, therefore, the single-
member LLC exception did not apply:

        EmeraChem, LLC did not become a disregarded entity for the purposes of
        franchise, excise tax. Under Tenn. Code Ann. § 67-4-2007(d), only LLC’s
        with a single corporate member are disregarded. EmeraChem, LLC’s
        single-member, the Taxpayer [EmeraChem Holdings] is an LLC that is
        treated as a partnership for federal income tax purposes. The Taxpayer
        [EmeraChem Holdings], therefore, is not a corporation for purposes of
        Tenn. Code Ann. §67-4-2007(d). And since EmeraChem, LLC’s single-
        member, the Taxpayer [EmeraChem Holdings] is not a corporation, the

        16
          The Commissioner’s notice is not evidence that the law was uncertain or that the Entities would
be reasonable in ignoring the plain language of the statute and rule. A notice can be issued for reasons
other than the lack of clarity in the law. For instance, the notice can be issued because of taxpayers
ignoring the eligibility requirement and subjecting themselves to penalties.
                                                 - 21 -
       SMLLC [single-member limited liability company] exception ... does not
       apply.

Considering the plain language of the statute, and the specific notices given to the
Entities, we cannot find that the Entities exercised due care in filing their consolidated tax
return for state excise tax or in failing to report their state excise tax separately.
Accordingly, the negligence penalty attributable to that failure was properly assessed and
will not be remitted.

       However, as to the negligence penalty attributable to the legal malpractice
settlement, we agree with the trial court that the penalty was not properly assessed and
must be remitted. “A court of equity, hearing a controversy between the State and a
taxpayer who has been assessed a penalty, has the power of remitting the penalties
imposed upon the taxpayer when the equities of the case demand.” James v. Huddleston,
795 S.W.2d 661, 664 (Tenn. 1990). Neither the Entities nor the Commissioner had ever
entertained the issue of how to classify the receipt of proceeds from the settlement of a
legal malpractice claim from another state. The issue was novel, unsettled, and unclear.
In light of this, the Entities acted in good faith with good and reasonable cause.

       The Commissioner’s decision to assess the excise tax required the Commissioner’s
auditor to consult with her office in Nashville and involved a number of people.
According to the auditor, she imposed the penalty on the entire amount of the assessment,
including the assessment arising from the filing of the consolidated tax return, the
assessment for the legal malpractice proceeds, and the assessment for the business tax,
because she was of the opinion that she had no alternative but to impose penalties on the
entire assessment. However, under Tennessee Code Annotated section 67-1-802 and -
803, the Commissioner’s authority to waive or abate penalties may be exercised to waive
or abate in “whole or in part, any statutory penalty imposed under any revenue laws
administered by the commissioner.” Tenn. Code Ann. § 67-1-802 and -803.

       We find that “the taxpayer acted in good faith upon a reasonable though mistaken
application of [the] law” in incurring the deficiency and that the Commissioner acted
under a mistaken application of law in assessing the penalty on the entire assessment
including that attributable to the legal malpractice proceeds. Benson v. U.S. Steel Corp.,
465 S.W.2d 124, 130 (Tenn. 1971). EmeraChem Holdings showed “good and reasonable
cause” and the equities of the case require the remission of the penalty attributable to the
legal malpractice settlement proceeds. Benson, 465 S.W.2d at 130 (holding that
taxpayers retain traditional right to invoke jurisdiction of equity to void inequitable
penalties in alternative to Tennessee Code Annotated section 67-1-804(e)(1965)).

       In summation, we affirm the judgment of the trial court as to both negligence
penalty issues. The negligence penalties attributable to the Entities’ consolidated filing

                                            - 22 -
were properly assessed and will not be remitted. The negligence penalties attributable to
the malpractice settlement proceeds were not properly assessed and will be remitted.



                                  V. CONCLUSION

       The judgment of the trial court is affirmed, and the case is remanded for such
further proceedings as may be necessary. Costs of the appeal are assessed against the
appellants, EmeraChem Power, LLC, EmeraChem Holdings, LLC, and EmeraChem,
LLC.


                                                  _________________________________
                                                  JOHN W. MCCLARTY, JUDGE




                                         - 23 -
