Tennessee State Income Tax
What kind of tax will you owe on Tennessee business income?
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Most states tax at least some types of business income derived from the state. As a rule, the details of how income from a specific business is taxed depend in part on the business’s legal form. More particularly, in most states corporations are subject to a corporate income tax, while income from “pass-through entities” such as S corporations, limited liability companies (LLCs), partnerships, and sole proprietorships is subject to a state’s tax on personal income. Tax rates for both corporate income and personal income vary widely among states; corporate rates, which more often are flat regardless of the amount of income, generally range from 4% to 9%, and personal rates, which generally vary depending on the amount of income, can range from 0% (for small amounts of taxable income) to around 9% or more in some states.
Currently, four states, Nevada, South Dakota, Washington, and Wyoming, do not have a corporate income tax, and the same four states, along with Alaska, Florida, and Texas, have no personal income tax. Individuals in New Hampshire and Tennessee are only taxed on interest and dividend income.
Apart from taxing business income through a corporate income tax or a personal income tax, many states impose a separate tax on at least some businesses, sometimes called a “franchise tax” or “privilege tax;” this is frequently defined as a tax simply for the right or “privilege” of doing business in the state. As with state taxes on business income, the specifics of a state’s franchise tax often depend in part on the legal form of the business. Franchise taxes are generally either a flat fee or an amount based on a business’s net worth.
Tennessee has both an excise tax, which is a tax on net earnings, and a franchise tax, which is a tax on net worth. Both of these taxes apply to most Tennessee businesses other than general partnerships and sole proprietorships. At the same, and as mentioned above, in terms of personal income, Tennessee only taxes interest and dividend income. Thus, while your Tennessee business itself may well be subject annually to two different types of state tax, any remaining income after these taxes that passes through to you personally from most so-called pass-through entities, such as LLCs or limited liability partnerships (LLPs), will not be subject to further taxation on your personal state tax return. (However, distributions to Tennessee shareholders from S corporations, which are also pass-through entities, are treated by Tennessee as taxable dividend income.)
Tennessee’s excise tax, which effectively is an income tax, is a flat 6.5% tax on net earnings from doing business in the state. All capital losses are claimed in the year incurred. Generally speaking, only general partnerships and sole proprietorships are exempt from the excise tax.
Tennessee’s franchise tax is based on the greater of a business’s:
- net worth; or
- book value of real and tangible property owned or used in Tennessee.
The rate is 25 cents per $100, or fraction thereof, of the business’s net worth. There is a minimum franchise tax of $100. In many instances, net worth will be defined as a business’s total assets minus its total liabilities; for businesses whose accounts are not maintained in accordance with generally accepted accounting principles, net worth will be based on whatever method the business used on its federal tax return. As with the excise tax, only general partnerships and sole proprietorships generally are exempt from the franchise tax.
Both the excise tax and the franchise tax are computed and paid using a single form (FAE 170). Returns are due on the 15th day of the fourth month after the end of a business’s tax year; for businesses whose tax year follows the calendar year, this means April 15th.
Let’s briefly look at additional details for five of the most common forms of Tennessee business: corporations (i.e., C corporations), S corporations, LLCs, partnerships, and sole proprietorships.
Corporations. Tennessee corporations are subject to both the excise tax and the franchise tax.
Example: For the 2012 tax year, your corporation had Tennessee net earnings of $500,000. Also, the net worth of your corporation, which is greater than the value of its real and tangible property, is $600,000. The corporation will owe excise tax in the amount of $32,500 (6.5% of $500,000). The corporation will also owe franchise tax in the amount of $1,500 (25 cents per $100 of total $600,000).
S Corporations. An S corporation is created by first forming a traditional corporation, and then filing a special form with the IRS to elect “S” status; unlike a traditional corporation, an S corporation is not subject to separate federal income tax. Furthermore, most states also do not subject S corporations to a separate income tax, and instead tax each individual shareholder on the portion of the corporation’s annual net income he or she receives. In other words, in most states, S corporations are pass-through entities. Tennessee, however, is different: it does not recognize the federal “S” election, and instead treats S corporations like traditional corporations, including requiring them to pay the same taxes as traditional corporations. In other words, like most other forms of business in Tennessee, S corporations are subject to both the excise tax and the franchise tax. In addition, Tennessee views S corporation distributions to Tennessee shareholders as taxable dividend income subject to the state’s income tax. At the same time, it appears wages or salary an individual shareholder receives from an S corporation are not subject to state income tax.
Example: For the 2012 tax year, your S corporation had Tennessee net earnings of $500,000. Also, the net worth of your corporation, which is greater than the value of its real and tangible property, is $600,000. The corporation will owe excise tax in the amount of $32,500 (6.5% of $500,000). The corporation will also owe franchise tax in the amount of $1,500 (25 cents per $100 of total $600,000). In addition, individual shareholders who receive dividends will owe tax to the state. However, shareholders will not owe tax on any salary or wages they may receive.
Limited Liability Companies (LLCs). In most states, standard LLCs are pass-through entities that are not required to pay either federal or state income tax. Instead, income from the business is distributed to individual LLC members, who then pay federal and state taxes on the amount distributed to them. Tennessee, however, is different: it does not treat LLCs as pass-through entities, and instead requires them to pay both the excise tax and the franchise tax. An individual member, however, does not owe state tax on whatever portion of the company’s net income he or she ultimately receives.
(Note that, while by default LLCs are classified for federal tax purposes as either partnerships or disregarded entities, it is possible to elect to have your LLC classified as a corporation. In that case, the LLC would be subject to federal corporate income tax; however, this change in classification would not affect the LLC’s Tennessee tax obligations.)
Example: For the 2012 tax year, your multi-member LLC, which has the default tax classification of partnership, had Tennessee income of $500,000. Also, the net worth of your company, which is greater than the value of its real and tangible property, is $600,000. The corporation will owe excise tax in the amount of $32,500 (6.5% of $500,000). The corporation will also owe franchise tax in the amount of $1,500 (25 cents per $100 of total $600,000). Individual members will not owe tax to the state on their respective shares of the company’s net income.
Partnerships. There are various types of partnerships, such as general partnerships, limited partnerships (LPs), and limited liability partnerships (LLPs), among others. In Tennessee, income from general partnerships is distributed to the individual partners; at that point, because the state has no personal income tax (apart from a tax on interest and dividends), no tax is due. However, other types of Tennessee partnerships, such as LPs and LLPs, must pay both the excise tax and the franchise tax.
Example: For the 2012 tax year, your general partnership had Tennessee net earnings of $500,000. As a general partnership, no excise tax or franchise tax is due. Moreover, because Tennessee has no personal income tax apart from interest and dividends, individual partners will not owe tax to the state on their respective shares of the partnership’s net income.
Sole Proprietorships. Income from your business will be distributed to you as the sole proprietor, and you will pay federal tax on that income; however, because Tennessee has no personal income tax apart from interest and dividends, you will not owe tax to the state on your business’s income.
Note on Multistate Businesses and “Nexus”
Our primary focus here is on businesses operating solely in Tennessee. However, if you’re doing business in several states, you should be aware that your business may be considered to have “nexus” with those states, and therefore may be obligated to pay taxes in those states. Also, if your business was formed or is located in another state, but generates income in Tennessee, it may be subject to Tennessee taxes. The rules for taxation of multistate businesses, including what constitutes nexus with a state for the purpose of various taxes, are complicated; if you run such a business, you should consult with a tax professional.
For further guidance on Tennessee’s excise tax and franchise tax, check the Department of Revenue website. For information on business-related taxes in other states, check Nolo’s 50-State Guide to Business Income Tax. And, if you’re looking for detailed guidance on federal income tax issues, check Tax Savvy for Small Business, by Federick Daily (Nolo).