A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in Tennessee, we know that it is a pass-through taxation structure. Typically, the profit LLC makes passes through the LLC to its members. Based on the profit share, members file their income tax returns. LLCs, unlike other corporations, do not have to pay income taxes based on profit or revenue.
IRS (Internal Revenue Service) allows LLCs to choose their preferable classification of tax at the beginning of the LLC formation. In general, a single-member LLC is taxed as a sole proprietor and a multi-member LLC is taxed as a partnership. As there is no fixed tax structure for LLCs, anyone certainly wants to opt for the most beneficial one. Keep reading till the end to know more about the tax structure of an LLC in Tennessee and related aspects.
On this page, you’ll learn about the following:
- Classification of Tennessee LLC Taxes
- LLC Taxes to be Paid in Tennessee
- Default LLC Tax Classification Rules
- Options to Change Default Tax Classification
- Choosing a Classification for Your LLC
- Classification of LLC Taxes – At a Glance
Classification of Tennessee LLC Taxes
An LLC is considered a Pass-through Entity because it allows the income to pass through & become self-employment income. The members of the LLC have to pay Self-employment tax or Self-Employment Taxes on any income they earn through the LLC. The LLC has to pay Franchise Tax on its income. In addition to the Self-employment tax, there are some other requirements that an LLC has to consider, such as:
- Franchise Tax – Franchise tax applies to or levies upon LLCs, C-corporations, & S-corporations. Sole Proprietorship & Partnerships (directly owned by individuals) are exempted from the Franchise Tax. This tax is to be paid with the office of the Comptroller of Public Accounts.
- Federal Tax Identification Number – An LLC with employees must obtain a Federal Tax Identification Number. Tennessee does not have a separate State Tax Identification number.
- State Employer Taxes – If an LLC has employees on the payroll, it must pay state employer taxes in Tennessee. These taxes are handled through Tennessee Workforce Commission.
- Franchise Tax Report – In Tennessee, the LLCs file a Franchise Tax Report with the Tennessee Department of Revenue.
Federal Tax Classifications
When LLCs was recognized as one of the types of Business Corporations, IRS did not create a new tax classification just for the LLC. LLCs were allowed to choose from the current tax classifications.
LLC Taxes to be Paid in Tennessee
An LLC based in the state of Tennessee is liable to pay the following kinds of taxes, in accordance with Tennessee classification of LLC taxes, to the Tennessee Department of Revenue:
State Income Tax
Some of the states have not levied income tax. Tennessee is one of them.
State Sales Tax
An LLC that is registered to carry on business in the state of Tennessee is liable to pay sales tax on the retail sale value of tangible products and services. It is collected in two portions- state and local portions. The state portion is taxed at the rate of 7%. The rate at which local portions are charged varies in different counties or cities. Sales tax is charged on the sales price of the items or services.
State Use Tax
In case the sales tax has not been charged on otherwise taxable products, and those products are being used within the state of Tennessee then you are liable to pay use tax. It is charged on the purchase price.
State Franchise & Excise Tax
For any LLC registered and operating in the state of Tennessee, it is important to pay the franchise and excise tax. The franchise tax is applied on either the book value of the properties owned by the LLC and used within the state boundaries or the net worth, whichever is greater. The gross earning for a financial year is applicable for excise tax.
Federal Self-employment Tax
Each shareholder or manager of a Tennessee LLC who produces a profit must pay the Federal Self-Employment Tax. The profits of each member of management are liable to the federal self-employment tax. The federal self-employment tax in Tennessee is 15.3 percent.
Federal Income Tax
The earnings you make in your LLC are subject to federal income tax. Your revenues, the industry in which your LLC operates, the suitable LLC tax bracket, reductions, and other considerations all play a role in determining your federal income tax rate.
Employee & Employer Tax
Any LLC having employees in the workforce must pay a number of taxes that are applicable to all personnel. With a few exceptions, employers doing business in Ohio are responsible for withholding Ohio personal income tax from their workers’ pay. All LLC employees must collect and withhold the Payroll tax when receiving a salary. Regardless of whether you withhold federal and state income taxes, your employees may need to file their own tax forms.
Default LLC Tax Classification Rules
By default, the LLCs are categorized as below (In both the categories, separate filing of income is not required):
Disregarded Entity (Single-Member LLC)
A single-member LLC is usually disregarded from the taxes. Hence a single-member LLC is also called a disregarded entity. Under the U.S. tax law, it is assumed that a single-member LLC is owned by an individual (& not by another LLC), so the U.S. tax law levies rules on it as a Sole Proprietor. Single-member LLC’s owner (Sole Proprietor) has to report all the income of the LLC via his own income tax return.
Sole Proprietorship Taxes
As mentioned earlier, the single owner of the LLC is treated as the Sole proprietor of the LLC & has to file the Self-Employment Tax on all of the LLC’s earnings. Tennessee does not levy State Income Tax, so a single-member LLC must file only the Federal Income Tax.
Partnership (Multi-Member LLC)
Any LLC with more than one owner is referred to as Multi- Member LLC & it is taxed as a partnership by default. Similar to the Single Owner or Single Member LLC, this LLC is also a pass-through entity. This means that the income of the LLC passes through the income of the members & they have to file taxes through their own earnings.
Partnership or Multi-Member LLC has to pay taxes similar to the Single Member LLC. If the Partnership LLC is directly owned by individuals, it is exempted from the Franchise Tax. All the members of the Multi-Member LLC are liable to pay Self-Employment Tax & Federal Income Tax.
Options to Change Default Tax Classification
The LLCs are categorized either as sole proprietorships or as partnerships, depending on the number of members the LLC has. This is the default tax classification applicable to LLCs. However, the LLCs have an option of changing the default classification & opting to register under the following categories for taxation purposes:
An LLC can prefer to be treated as a C-corporation by filing form 8832 (the Entity Classification Election Form) with the IRS. The C-corporation is a regular corporation that is subject to corporate taxes & it is not a pass-through entity.
An LLC taxed as a C-Corporation is not a pass-through entity. In a C-corporation, the members/shareholders/ owners are taxed separately. The shareholders of the C-corporation are taxed twice on the dividends that they earn. The dividends of the shareholders are taxed at the corporate level – with a Corporate Tax filed with Form 1120 & at a Shareholder level – an Income Tax filed with Form 1040. Shareholders are subjected to Federal Income Tax.
The S-Corporation is the most common type of corporate structure used by small businesses. It was created to provide corporations with limited liability protection while maintaining the benefits of being a separate legal entity. An LLC can prefer to be treated as S-Corporation by filing Form 2553. S-corporations are small business corporations, that choose to pass through the corporate income, losses, deductions, & credits to the shareholders for the purposes of Federal Taxes.
An S-Corporation is similar to an LLC except that it is treated by the IRS as a corporation for tax purposes. S-Corps do pay corporate income taxes; however, they are still considered disregarded entities for federal tax purposes.
Like an LLC, an S-Corp reports its annual earnings on a separate Schedule E on the member’s personal account. An S-Corp is treated by the IRS much like a partnership for tax purposes. Unlike Partnership, in S Corporation, the shareholders are required to pay Federal Self Income tax on their share of the company’s profits.
Choosing a Classification for Your LLC
In terms of owners’ protection against liability, perpetual existence, & savings in Taxation, Both LLCs (Limited Liability Companies) & Corporations are very much alike. However, with regard to formalities, Taxation, & capital, LLCs & Corporations differ in Tennessee.
Both LLCs and Corporations provide liability protection to their owners. The LLC provides protection against inside liability (towards the employee) & outside liability (towards the creditor). The Corporation usually provides only the inside liability.
Tax Classification Flexibility
For taxation purposes, an LLC has a choice of being treated as a sole proprietorship, Partnership or C-corporation or S-corporation. A corporation can choose to be treated only as C or S Corporation.
As mentioned earlier, the LLC can choose to be treated as a corporation; the Corporation does not have the option of being treated as the LLC. A Tennessee LLC is subjected to Franchise tax, Federal Income Tax, Sales & Use Taxes & State Employment Taxes (for LLCs that have employees)
A regular corporation or a C- Corporation is subjected to corporate tax, which can be filed through Form 1120 every year. The shareholders have to pay the Income-tax, only when they receive dividends from the Corporation. These dividends are taxed twice at the corporate level (on a corporate form)& at the shareholder level (on shareholder form).
An S- Corporation in LLC is not subjected to corporate taxes. But the shareholders are subjected to Taxation – even if they do not receive any dividends. A member of a Tennessee S-corporation has to pay Federal Self employment Tax only on his salary; any other profits that he makes through the LLC are not subject to the 15.3% Self Employment Tax.
Classification of LLC Taxes – At a Glance
|Points of Difference||LLC||S- Corporation||C-Corporation||Sole Proprietorship|
|Taxation||As an LLC, by default, there is no tax levied at the entity level. The members’ income or even the loss is passed through to members or owners.||Similar to LLC, no tax is levied on an S-Corporation at the entity level. The members’ income or even the loss is passed through to members or owners.||The C-Corporation is often taxed at the entity level. The Dividends are taxed at the shareholders’ level.||The Sole- proprietorship as an entity is not taxable. The Sole Proprietor pays taxes as an Individual.|
|Double Taxation||The LLC does not have Double Taxation||There is no Double Taxation in S-Corporation||There is Double Taxation in C-Corporation, only when the Shareholders earn in the form of dividends.||No Double Taxation in a sole proprietorship.|
|Self Employment Tax||The net income of the members or owners is subject to self-employment tax.||The salaries of the shareholder are subject to self-employment tax, but any other profits that the shareholder makes are not subject to the employment tax.||The C-Corporation is subject to self-employment tax.||The Sole-proprietorship is subject to self-employment tax|
|Pass-Through Income/Loss||An LLC is often referred to as a Pass-through entity because its income passes through/ passes to its members.||Yes, An S Corporation is a Pass-through Entity.||No, A C-Corporation is not a Pass-through Entity.||Yes, A Sole-proprietorship is a Pass-through Entity.|
How Do LLCs Pay Taxes in Tennessee
Any LLC operating in Tennessee is liable to pay 2 kinds of taxes- state taxes as well as federal taxes.
LLCs are classified as a pass-through entity for tax purposes. Unlike corporations, LLCs are not subject to double taxation. This means that the LLC itself does not pay federal income taxes. Instead, the profits and losses of the LLC ‘pass through’ to its owners, or members, who report them on their personal tax returns. This element of pass-through taxation ensures that income is only taxed once, thus preventing the double taxation commonly associated with corporations.
For LLCs operating in Tennessee, income taxation is no exception to this pass-through principle. Due to the absence of an income tax at the state level, Tennessee does not impose a specific tax on LLC income. Therefore, LLCs avoid the additional burden of state-level taxation on top of their federal obligations. The lack of a state income tax is undoubtedly an appealing aspect for LLCs operating in Tennessee, as it alleviates a significant financial burden and enhances the state’s attractiveness as a business-friendly environment.
Instead of relying on income taxes, Tennessee predominantly generates its revenue through sales tax and franchise and excise taxes. These forms of taxation are typically imposed on both LLCs and other types of businesses operating in the state. LLCs engaged in retail or service-oriented businesses are particularly impacted by sales tax, as they collect and remit sales tax on behalf of the state and local government entities. Franchise and excise taxes, on the other hand, are based on the net worth or taxable income of the LLC, ensuring that all businesses contribute to state revenues regardless of their specific industry or business model.
It is crucial for LLC owners in Tennessee to be aware of their tax obligations and ensure compliance by monitoring their income and readying proper tax filings. Additionally, LLC members must stay abreast of any changes in tax regulations at both federal and state levels to avoid unintended consequences or penalties associated with noncompliance.
While understanding LLC taxation can be a complex task, utilizing the expertise of a qualified tax professional can help mitigate any confusion or potential errors. By partnering with an experienced tax consultant or accountant who specializes in LLC taxation, businesses can ensure accurate and timely submission of tax forms and declarations, ultimately minimizing financial risks and achieving peace of mind.
In summary, LLC taxation in Tennessee follows the general principles of pass-through taxation. LLCs in the state do not pay income taxes at the state level, thanks to the absence of a state income tax. Instead, sales tax and franchise and excise taxes play prominent roles in generating revenue for the state. LLC owners must remain vigilant regarding their tax obligations and seek expert advice to navigate the intricacies of LLC taxation effectively.
C-Corporation. It taxes the dividends of the shareholders at the corporate level as well as at an individual level.
An LLC is often referred to as the pass-through entity because the income or the assets pass through the members or owners of the LLC.
The LLCs have two default classifications. It can be termed as a single-member LLC or a multi-member LLC.
When choosing a different classification for taxation, it is essential to understand the liabilities & taxes applicable in that classification.
Every Tax classification has its own set of benefits & restrictions. Every state will have different taxation rules for each of the categories of business corporations. Depending on the objective of formation of the business entity (Eg. To avoid dual Taxation- one can choose S Corporation, for more flexibility, one can choose the LLC format). It is essential to understand the taxing structure of each country & each Classification; to decide how you wish to treat your LLC.