File an S Corp in Tennessee

Embarking on the journey to establish an S corporation in Tennessee? An “S corp” represents a special tax classification that can be applied to both LLCs and traditional corporations, offering a pathway to potentially reduce your tax obligations. This guide will navigate you through the steps to set up an S corp in Tennessee, pointing out the specific procedures and advantages associated with starting your business in the Volunteer State.

For limited liability companies (LLCs) in Tennessee, electing S corp status may lead to opportunities for self-employment tax savings. For C corporations, adopting an S corp designation can help avoid the pitfalls of double taxation on profits at both the corporate and shareholder levels.

Limitations and Requirements of S Corporations

You must be aware of the S corp filing requirements and limitations before you begin this process. To qualify to be an S corporation, a business entity must:

• Be a domestic corporation or LLC
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Have only one class of stock
• Have no more than 100 shareholders or members (“shareholders” is the term for owners of a corporation, while “members” is the term for owners of an LLC)
• Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders/members may not be partnerships, corporations, or non-resident aliens. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.

And so, not all business entities are eligible for S corp election. However, if your business entity meets these criteria, you can apply for an S corp status. 

Tennessee-Specific Considerations

In an S corp, the business itself doesn’t usually pay federal income taxes. But what about state income taxes?

Tennessee doesn’t recognize S corp status at the state level, meaning that your S corp will be treated like a C corporation for state tax purposes. Just like C corporations, S corporations must pay a 6.5% excise tax in addition to a franchise tax, which is equal to the greater of $0.25 for each $100 of net worth or actual value of tangible property, but no less than $100. However, Tennessee has no personal income tax.

How to Start an S-Corp in Tennessee

To have a Tennessee S corporation classification, you’ll need to start either an LLC or a C corporation if you haven’t already done so. Then, you’ll file an election form with the Internal Revenue Service (IRS).

S-Corp Election Steps for LLCs

For detailed formation steps, see our Tennessee LLC formation guide.

• Step 1 – Choose a name for your Tennessee LLC 
• Step 2 – Appoint a Tennessee registered agent
• Step 3 – File Tennessee Articles of Organization
• Step 4 – Create an operating agreement
• Step 5 – Apply for an EIN
• Step 6 – Apply for S Corp status with IRS Form 2553

S-Corp Election Steps for Corporations

For detailed formation steps, see our Tennessee Corporation formation guide.

• Step 1 – Name your corporation
• Step 2 – Appoint directors
• Step 3 – Choose a Tennessee registered agent
• Step 4 – File the Tennessee Corporate Charter
• Step 5 – Create corporate bylaws
• Step 6 – Draft a shareholder agreement
• Step 7 – Issue shares of stock
• Step 8 – Apply for necessary business licenses or permits
• Step 9 – File for an EIN and review tax requirements
• Step 10 – Submit your corporation’s first annual report
• Step 11 – Apply for S Corp status with IRS Form 2553

File the form to apply for S corp status 

Submit the application for S corp status. Once your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status. 

The IRS requires that you complete and file your Form 2553: 

• Within 75 days of the formation of your LLC or C corporation, or no more than 75 days after the beginning of the tax year in which the election is to take effect

OR

• At any time during the tax year preceding the tax year the election is to take effect.

For LLCs wishing to file as an S corp, please note: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail. 

All of the shareholders/members must sign the consent statement portion of the form. For more information on when and how to file Form 2553, visit the IRS website.

Pluses and Minuses of Filing as an S Corp

While S corp classification does come with benefits for some businesses, making this election might not be right for all companies. So, be sure to carefully weigh the various pros and cons before deciding how you want to move forward. It’s always wise to consult a tax professional about whether the S corp election would be best for your business.

Pros of S Corp Status for LLCs

The advantages of filing as an S corp for an LLC differ from those for filing as a C corporation. Let’s look at the advantages for LLCs first.

A typical LLC already has pass-through taxation, so the benefits of S corp election for an LLC have to do with self-employment taxes. Let’s explain how it could provide tax benefits for certain LLCs.

Self-Employment Taxes Explained

The members of a standard LLC are considered self-employed. They receive money from the business through their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (Social Security and Medicare, which add up to about 15.3%) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay half of them.

Dividing Profits and Salary

But when the members elect S corp status, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee of the LLC. Once they do that, they only pay Social Security and Medicare taxes on their salary and not the profits they receive. Depending on factors such as how profitable your company is, the savings could add up to a lot. (Of course, the members will still pay income and all other applicable taxes on their share of the profits.) Note that money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

One catch to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of 16 bucks and avoid contributing anything to Social Security and Medicare. 

So, what is “reasonable compensation” in the eyes of the IRS? The instructions on Form 1120-S read, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” While the terms aren’t completely defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning.

If the IRS doesn’t find your salary to be reasonable, it has the authority to reclassify your non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases have supported the IRS’s right to do this.

Advantages of S Corp Status for C Corporations

If you have a C corporation, filing as an S corp has notable advantages:

Pass-Through Taxation

One big disadvantage for traditional corporations is “double taxation.” When the corporation makes money, the IRS taxes those profits on the corporate level. But when those profits are ‌distributed to the individual shareholders as dividends, they’re taxed a second time on the shareholders’ personal tax returns.

But when a C corporation qualifies to be an S corp, those profits are only taxed at the individual business owner level. The company itself isn’t taxed on them. This is called “pass-through taxation,” and it’s how sole proprietorships and general partnerships are taxed. LLCs are also taxed this way unless they choose to be taxed as a corporation.

We need to add here that, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. So, the disadvantages of double taxation aren’t as big of a deal as they were. 

Ability to Write Off Losses

Just as business profits pass through to the owners of an S corp, so do the losses. Unlike C corporation shareholders, S corp owners can write off the company’s losses on their personal income statements. 

This can help offset their income from other sources and can be helpful if the corporation loses money in the first couple of years. However, make sure you’re aware of ​​the IRS’s shareholder loss limitations.

Qualified Business Income Deduction

Under the Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income (“QBI” for short). This deduction isn’t available to C corporation shareholders.

QBI is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. There’s an income threshold that may reduce your QBI if exceeded (see the IRS website for details).  

Minuses of S Corp Status for LLCs

Having an LLC with S corp status can have some drawbacks over a standard LLC:

Stricter Requirements 

As we listed above, S corps have more qualifications than a standard LLC. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.

More Scrutiny

Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS monitors LLCs filing as S corps more closely. That could mean a greater chance of being audited, even if you follow the law to the letter. In fact, S corp owners may want to observe some of the same formalities that C corporations do (such as regular meetings and extensive record keeping), even if they’re not legally required to.

Additional Accounting and Bookkeeping

Having an LLC filing as an S corporation generally means more paperwork. If you don’t already have to do payroll for your business, being an owner-employee means that you’ll have to do so. Your taxes will be more complex, as well.

With these added complexities, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.

Disadvantages of S Corp Status for C Corporations

S corp status also has its drawbacks:

Limited Number of Shareholders

An S corp can’t have more than 100 shareholders, while a C corporation has no such restriction. That limitation could be an issue later if the corporation expands and goes public.

Limited Shareholder Types

All S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand beyond the U.S. You also can’t have partnerships or corporations as shareholders. C corporations don’t have these limitations.

One Class of Stock

One way corporations attract investors is to offer preferred stock, but the IRS doesn’t allow it for S corps.

More IRS Scrutiny

Because of the restrictions S corps have, the IRS watches them more closely to see if they’re in compliance. In other words, your corporation is more likely to get audited.

Again, it’s important to have tax guidance about your specific situation from a qualified tax professional. An accountant with S corp experience should be able to make sure you stay in compliance with the IRS, and they may also be able to help you find additional tax savings.

S Corp Tax Calculator

The S Corporation tax calculator below lets you choose how much to withdraw from your business each year, and how much of it you will take as salary (with the rest being taken as a distribution.) It will then show you how much money you can save in taxes.

Disclaimer: The savings estimate provided by this tool is for informational purposes only and should not be considered financial, tax, or legal advice. Actual savings may vary depending on individual circumstances and other factors. We recommend consulting with a qualified tax or legal professional before making any decisions regarding your business entity. ZenBusiness, Inc. is not responsible for any actions taken based on the information provided by this tool. Use of this tool does not establish any client relationship with ZenBusiness, Inc.

Get help establishing a Tennessee LLC with S corp tax election

Forming a business can be challenging, but we’re here to make it as easy for you as possible.

When you’re ready to launch your dream business, we can help you form a Tennessee LLC with an S corporation designation and provide you with valuable support for all of your business needs moving forward. Contact us today to get started.