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. 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 most often are flat regardless of the amount of income, generally range from roughly 4% to 10%. 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, six states—Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming – do not have a corporate income tax. However, four of those states—Nevada, Ohio, Texas, and Washington—do have some form of gross receipts tax on corporations. Moreover, five of those states—Nevada, South Dakota, Texas, Washington, and Wyoming—as well as Alaska, Florida, and Tennessee currently have no personal income tax. Individuals in New Hampshire 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 justified as a tax simply for the 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, Tennessee has no personal income tax. So, 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.
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:
The rate is 25 cents per $100, or fraction thereof, of the business's net worth. The minimum franchise tax is $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.
Here's a brief 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.
Tennessee corporations are subject to both the excise tax and the franchise tax.
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 they receive. 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. At the same time, dividends, wages, or salary an individual shareholder receives from an S corporation are not subject to state income tax.
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 they ultimately receive.
(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.)
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 and at that point, because the state has no personal income tax, 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.
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, you will not owe tax to the state on your business's income. Sole proprietors are not subject to the Tennessee franchise and excise taxes.
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 might be considered to have nexus with those states and, therefore, might 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 might 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, consult with a tax professional.
For further guidance on Tennessee's excise tax and franchise tax, check the Tennessee Department of Revenue. 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 Frederick Daily (Nolo).
Updated February 9, 2022