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Choosing Between an S Corp and LLC in Tennessee: A Guide to Making the Right Decision for Your Business

April 26th, 2024 | 3 min. read

By Matt Patrick

Deciding on the legal structure of your business might seem like choosing between coffee or tea in the morning – both have their perks, right? But in reality, it’s more like choosing between a backpack and a suitcase for a long journey. Each option suits different paths, terrains, and destinations.

For small business owners, especially in the vibrant landscape of Tennessee, this decision can feel overwhelming. You’ve heard terms like “S Corp” and “LLC” tossed around, maybe in a seminar, a blog post, or by that friend who also runs a business. But what does it all really mean for you and your dreams?

At Patrick Accounting, we understand that behind every question about business structures is a business owner looking to simplify their financial world, make smarter decisions, and ultimately, build the business they’ve always dreamed of. We’re here to help you unpack the suitcase of information, sort through it, and repack it in a way that makes your journey forward clear and confident.

Understanding the Basics: How S Corps and LLCs are Taxed

Before diving into the nitty-gritty, let’s start with a mini crash course in taxes (don’t worry, we’ll keep it as painless as possible).

S Corporations

Think of an S Corp as a pass-through entity. This means the company itself doesn’t pay taxes on its profits. Instead, the profits “pass through” to you, the owner, and you report them on your individual tax return. The beauty? You’re typically taxed at your personal income tax rate, which can be a win depending on your income bracket. Plus, you can save on self-employment taxes. But remember, it’s not all sunshine; there are specific rules you have to follow.

LLCs Taxed as Partnerships

LLCs are super flexible. By default, they’re also pass-through entities, meaning the business’s income passes through to your personal tax return. But here’s where it gets cool: LLCs can choose how they want to be taxed (like a corporation, partnership, or even as an S Corp). Flexibility is the name of the game with LLCs, but with great power comes great responsibility (and sometimes more paperwork).

How This Affects Your Tax Return

When it comes to tax time, both structures involve reporting your share of the business’s profits on your personal tax returns. 

For S Corps, you’ll get a Form K-1 showing your share of the income (or loss), which you’ll report on your Form 1040. 

For LLCs, the process is similar, but how you report depends on how you’ve chosen to be taxed.

Pros and Cons: S Corp vs. LLC in Tennessee

Now, let’s get into the meat of it. In Tennessee, choosing between an S Corp and an LLC isn’t just about tax rates or fancy legal terms. It’s about understanding how these structures align with your business goals, your personal risk appetite, and yes, your dreams for the future.

Pros of S Corp

Tax Advantages: S Corps allows profits (and some losses) to be passed directly to owners’ personal income without being subject to corporate tax rates, avoiding double taxation.

Salary and Dividend Payments: Shareholders can receive both salaries and dividend payments, which can be beneficial for tax planning.

Credibility: Being an S Corp can add credibility to a business as it may be perceived as more formal or established than an LLC.

Investment Opportunities: S Corps can attract investors through the sale of shares.

Con of S Corp

Stricter Qualification Requirements: There are limits on the number and type of shareholders (100 shareholders maximum and shareholders must be U.S. citizens or residents).

More Rigid Formalities and Regulations: S Corps have more stringent operational processes, including requirements for annual meetings and the maintenance of corporate minutes.

Salary Requirements: Shareholders who work for the company must receive a reasonable salary, which is subject to employment taxes.

Limited Growth Potential: The limitations on the number of shareholders can restrict investment opportunities and growth.

Pros of an LLC 

Flexibility in Management: LLCs offer more flexibility in management and business practices without the need for a board of directors or annual meetings.

Tax Choices: LLCs can choose how they are taxed (as a sole proprietorship, partnership, S Corp, or C Corp), providing flexibility in financial planning.

Less Stringent Compliance Requirements: LLCs face fewer compliance requirements and formalities compared to S Corps.

Limited Liability Protection: Owners have limited liability for business debts and obligations, similar to S Corps.

Cons of an LLC

Self-Employment Taxes: Unless an LLC elects to be taxed as an S Corp, profits may be subject to self-employment taxes.

Varied State Laws: The rules governing LLCs can vary significantly from state to state, potentially complicating multi-state operations.

Ownership and Investment Limitations: Some investors may hesitate to invest in LLCs due to the perceived lack of formality and the potential for more complicated ownership structures.

Limited Life Span: In some states, LLCs have a limited lifespan and may be required to dissolve or re-form after a certain period or upon the departure of a member, though this is not universal.

The Tennessee Context: H.B. 323 and Its Impact

For business owners in Tennessee, the recent changes under H.B. 323 add another layer to consider. With adjustments to franchise and excise tax laws, the single sales factor phase-in, and an exemption for the first $50,000 of net earnings from excise tax, you’ll need to crunch some numbers (or let us do it for you) to see which structure offers the best benefits for your specific situation.

Making the Decision: S Corp vs. LLC

Choosing the right entity isn’t about finding the universal best option; it’s about finding the best option for you. Consider your growth plans, your income, how you want to manage your business, and let’s not forget, your peace of mind.

Deciding on the best legal structure for your business can impact everything from your taxes to your daily operations. Curious about the tax benefits of your chosen entity? Dive deeper into the tax advantages of S Corps and LLCs with our detailed analysis to help you make the most informed decision for your business.