As a Tennessee business owner, seeing your company succeed and turn into a well-established business is a dream come true. However, growth may lead to tax rate increases as well. That is why many growing businesses tend to face various complexities during the tax season.
So what can you do? Well, you may want to consider starting a Tennessee S corp. Doing this can give you significant advantages in terms of taxation while preserving the flexibility that your business entity structure offers. It is a big decision to make, so you have to think about it carefully.
Understanding What It Is
S corp stands for subchapter S corporation, and it is sometimes known as a small business corporation. What you need to understand is that it is not a business entity structure. It is a tax code that aims to support and encourage small and family businesses.
Generally, it is the same as a corporation except for the manner of taxation. If you choose to elect S corp status, your company can be taxed as a partnership based on federal law. You will not pay federal income taxes. Instead, all tax liabilities for the company’s earnings and losses will be passed through to the owners of the company. No matter how many people organized the business, it will be treated as a single entity.
Here are the main features that you have to understand:
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- No double taxation
- Pass-through taxation
- Limited liability protection
- Not more than 100 owners at a time
- Only one type of stock
- Transferable stock
- A domestic business entity
- All owners are US citizens
- Business entities cannot serve as owners or directors
You also need to remember that not all types of businesses can be an S corp. The Internal Revenue Service (IRS) restricts certain types of general corporations from taking this tax status.
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- Banks
- Insurance companies taxed under subchapter L
- Domestic international sales corporations (DISC)
- Certain affiliated groups of corporations
Advantages Of An S Corp
Starting a Tennessee S corp comes with a lot of benefits. Here are some of the things that may help your business:
- Tax Advantages – The main reason why many entrepreneurs choose to elect S corp status is to gain tax advantages, which include federal income tax exemption except for certain capital gains or passive income. Since it allows pass-through taxation, taxes will only be on the personal tax returns of owners. Because of this, you can be sure that your company’s profits will only be taxed once.
- Asset Protection – If your company is an S corp, your personal assets will have legal protection since they remain separate from business assets. Owners will not have personal liability for the debts of the company, and creditors will not be able to go after your assets to recover the debts of your business.
- Flexible Characterization Of Income – As the owner of an S corp, you will have the flexibility in choosing how to characterize income for tax purposes. You can be considered as an employee of the company so that you can pay yourself a salary. Additionally, you can pay yourself with dividends from the company or distributions that are either tax-free or have lower rates than the salary of an employee. With this, you can reduce self-employment tax liabilities.
- Transferring Of Ownership – Another advantage of a Tennessee S corp is that it allows easy transfer of ownership. There will be no significant tax consequences. You also do not have to terminate the company. Transferring S corp ownership does not require any adjustment to properties. There will also be no need to comply with complicated accounting regulations.
Forming A Tennessee S Corp
Choosing to elect S corp status can help your company save a lot on payroll and income taxes. The process is also not as complicated as some people may think. You can do it by following these steps:
Step 1: Form a Tennessee corporation or LLC.
Since an S corp is not a business entity structure, you will have to create a company in Tennessee first. You can choose either a corporation or a limited liability company (LLC) as the base. To do this, you have to submit the proper formal paperwork. If you choose an LLC, it will be an Articles of Organization form. It comes with a $300 filing fee. Meanwhile, a corporation needs to file a For-Profit Corporation Charter that costs $102.35. Submit the documents to the Secretary of State.
When forming a Tennessee business entity, you have to make sure that the name follows the state naming guidelines. Generally, you need to include the appropriate indicator. You cannot use any word that could confuse your company for a government agency. You also need to make sure that the name you choose is distinguishable. You can check this by conducting a business entity name search.
Step 2: Appoint a registered agent.
Tennessee requires all companies to have a registered agent to receive all legal documents and services of process on behalf of the company. You can choose an individual or a business entity that agrees to the appointment.
If you choose an individual, they should have the following characteristics:
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- At least 18 years old
- Has a physical street address in Tennessee
- Available during normal business hours
If you opt for a commercial registered agent, make sure they qualify.
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- Authorized to transact in Tennessee
- Has a physical street address in the state
- Available during normal business hours
Step 3: Obtain an Employee Identification Number (EIN).
After forming your Tennessee corporation or LLC, you have to get an EIN from the IRS. You can do this by submitting a completed SS-4 form. You can download a copy from the official website of the IRS. This registration is free of charge.
Step 4: Issue stocks and prepare the initial documents.
If you choose to form a corporation, then you will have to issue stock to shareholders through the form of stock certificates. Make sure your corporate secretary record all issuances in the company’s ledger with the following pieces of information:
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- Issuance date
- Name of the stockholder
- Number of issued shares
- Price per share and the total purchase price
- Capital contribution, if it is different from the purchase price
- Stock certificate numbers
If you want your Tennessee corporation to qualify for S corp election, keep the following limitations on the capital structure and nature of shareholders that the federal law has set:
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- The number of owners cannot be more than 100 at a time. In some cases, spouses, certain family members, and their estates can qualify as a single shareholder.
- Only individuals, estates, certain trusts, and entities that are exempted from federal income taxes can be shareholders.
- Nonresident aliens cannot be shareholders.
- There should only be one class of stock.
Additionally, you should check with the Secretary of State all of the necessary documents that you have to file in order to prevent any issues. For example, a corporation needs to complete certain legal documents like the following:
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- Bylaws that spell out the rules on how to manage the company
- Initial resolution of shareholders electing the members of the board of directors and adopting the bylaws
- Initial resolution of the board of directors appointing the officers of the corporation, which include the president, secretary, and treasurer
- A standard stock certificate
Step 5: Elect the S corporation.
The last step in starting a Tennessee S corp is electing to be treated as one. To do this, you will have to submit a completed Form 2553 to the IRS. The agency will evaluate if you are eligible for this tax treatment.
Remember that an S corp status will only change the way your business entity is treated in terms of federal income taxes. It will not change the tax obligations of your company at the state level. That means your state taxes will still depend on the business entity structure that you choose when you form your Tennessee company.
Electing an S corp in Tennessee will provide protection and flexibility for your company. However, you have to complete the whole process. That means you need to research and understand the requirements. If you need help in handling the paperwork and ensuring business compliance, contact DoMyLLC.