Should You Elect S Corp Status in Tennessee? What Business Owners Need to Know

If you've talked to a business owner, read a tax blog, or spent any time on LinkedIn, you've probably heard that electing S Corp status is a tax no-brainer. The pitch is simple: Pay yourself a reasonable salary, take the rest as distributions, and avoid self-employment tax on those distributions.

For some business owners, that math works out. But the decision is more nuanced than the standard advice suggests, especially in Tennessee.

When you factor in Tennessee's franchise and excise tax, the QBI deduction that sole proprietors enjoy, and the real overhead costs of running an S Corp, the picture changes. What looks like obvious tax savings on paper may not be as clear-cut in practice.

Here's what you need to understand before making the S Corp decision in Tennessee.

The Standard S Corp Argument

First, let's understand why the S Corp election is so widely recommended.

When you operate as a sole proprietor or single-member LLC, all your business profit is subject to self-employment tax (Social Security and Medicare), which totals 15.3% on the first $184,500 of net earnings in 2026, and 2.9% on anything above that.

When you elect S Corp status, you become an employee of your own business. You pay yourself a "reasonable salary," and that salary is subject to payroll taxes. But any profit above your salary can be taken as shareholder distributions, which are not subject to self-employment or payroll taxes.

On the surface, the math looks compelling. But this simple comparison leaves out several important factors.

What the Simple Math Misses

The standard S Corp pitch focuses only on self-employment tax savings. But there are three factors that often get overlooked:

1. The QBI Deduction Favors Sole Proprietors

The Qualified Business Income (QBI) deduction allows eligible business owners to deduct up to 20% of their qualified business income from their taxable income. This is a significant tax benefit that's easy to overlook in the S Corp analysis.

Here's the key difference:

• Sole proprietors: Get the QBI deduction on their entire business profit

• S Corp owners: Only get the QBI deduction on distributions, not on salary

So if your business generates $150,000 in profit:

As a sole proprietor, you might deduct 20% of $150,000 = $30,000 from your taxable income.

As an S Corp paying yourself a $70,000 salary, you only get the QBI deduction on the $80,000 in distributions = $16,000 deduction. You've lost $14,000 in deductions by paying yourself a salary.

Depending on your tax bracket, that lost QBI deduction could cost you $3,000 or more in additional income taxes, eating into your self-employment tax savings.

2. Tennessee's Franchise and Excise Tax

Tennessee doesn't have a personal income tax on wages and business income. But it does have a franchise and excise tax that applies to most business entities, including S Corps.

The excise tax is 6.5% of net earnings above the first $50,000 (which is exempt). The franchise tax is 0.25% of net worth, with a minimum of $100.

Both sole proprietors and S Corps pay the minimum $100 franchise tax. But sole proprietors and single-member LLCs that are disregarded for tax purposes do not pay the excise tax. S Corps do.

The $50,000 exemption helps, but if your S Corp has significant profit above your salary, the excise tax adds up.

3. The Hidden Costs of Running an S Corp

This is the factor most generic tax advice completely ignores: S Corps cost real money and time to maintain.

Ongoing Administrative Costs:

• Payroll processing: You'll need a payroll service to handle your salary, withholdings, and quarterly payroll tax filings. Expect to pay $500 to $1,500 or more per year.

• Additional tax returns: S Corps file Form 1120S, a separate business tax return. If you use a tax professional, this adds $1,000 to $2,000 or more to your annual tax prep costs.

• Tennessee F&E filing: You'll file the Tennessee franchise and excise tax return annually, adding more complexity and potentially more professional fees.

• Bookkeeping complexity: S Corps require cleaner separation between business and personal finances, proper documentation of shareholder distributions, and more detailed record keeping.

Legal and Compliance Requirements:

• Reasonable compensation documentation: The IRS requires S Corp owners to pay themselves a "reasonable salary." You need to document how you determined your salary is reasonable for your industry, experience, and role. This isn't optional; it's one of the most common S Corp audit triggers.

• Shareholder agreement: A formal agreement documenting ownership, rights, and responsibilities. Important even for single-shareholder S Corps.

• Annual meeting minutes: S Corps are required to hold annual shareholder meetings and document the minutes, even if you're the only shareholder.

• Accountable plan: If you reimburse yourself for business expenses, you need a written accountable plan to avoid those reimbursements being treated as taxable income.

• Corporate formalities: Maintaining separate bank accounts, proper corporate records, bylaws, and resolutions for major decisions.

The Time Cost:

All of this paperwork and compliance takes time. Time spent on corporate formalities is time not spent serving clients or growing your business. That has a real cost, even if it doesn't show up on a spreadsheet.

All told, the overhead of maintaining an S Corp properly can easily run $2,000 to $5,000 or more per year when you factor in professional fees for setup, ongoing compliance, and tax preparation. That's money coming directly out of your supposed tax savings.

Putting It All Together: A More Complete Picture

Let's look at a realistic scenario that factors in all of these variables.

Scenario: $100,000 business profit

As a Sole Proprietor:

• Self-employment tax: ~$14,100

• QBI deduction (20% of ~$100,000): ~$20,000 deduction, saving ~$4,800 in income tax (at 24%)

• Tennessee franchise tax: $100

• Additional overhead: Minimal

• Net tax cost: ~$9,400

As an S Corp ($60,000 salary, $40,000 distributions):

• Payroll taxes on salary: ~$9,200

• QBI deduction (20% of $40,000): ~$8,000 deduction, saving ~$1,920 in income tax

• Tennessee excise tax: $0 (profit after salary is under $50K exemption)

• Tennessee franchise tax: $100

• S Corp overhead (payroll, tax prep, compliance): ~$2,500

• Net tax cost: ~$9,880

At $100,000 in profit, the S Corp actually costs more when you factor in QBI and overhead. And this doesn't account for your time dealing with the added complexity and compliance requirements.

The S Corp advantage only becomes meaningful at higher profit levels where the self-employment tax savings significantly outweigh the lost QBI deduction, overhead costs, and compliance burden.

When S Corp in Tennessee Might Make Sense

S Corp election may be worth considering if:

• Your business consistently generates substantial profit well above a reasonable salary

• The self-employment tax savings clearly outweigh the lost QBI deduction and overhead costs

• You already have employees and are running payroll anyway

• You're comfortable with the compliance requirements and corporate formalities

• Business credibility or corporate structure matters for your client base

• You have long-term plans that benefit from corporate structure

When Staying a Sole Proprietor or LLC Might Make Sense

Maintaining your current structure may be the better choice if:

• Your profit level doesn't clearly justify the added cost and complexity

• Your income fluctuates significantly year to year

• You value simplicity and want to minimize paperwork and compliance

• The QBI deduction on your full profit is more valuable than the SE tax savings

• You'd rather invest the overhead costs back into your business

• You don't want to deal with reasonable compensation documentation and audit risk

The Bottom Line on S Corp Status in Tennessee

S Corp election can be a valuable tax strategy, but it's not the slam dunk that generic advice makes it out to be.

When you factor in the QBI deduction that favors sole proprietors, Tennessee's franchise and excise tax, and the real costs of maintaining an S Corp (payroll, tax prep, compliance, reasonable compensation documentation, corporate formalities), the break-even point is higher than most business owners realize.

Before making the S Corp election, work with a tax professional who can run the complete numbers for your specific situation. Consider not just the potential tax savings, but the lost deductions, the overhead costs, the compliance burden, and the value of your time.

The goal isn't to follow a formula or chase a tax strategy you heard about online. It's to make an informed decision that aligns with your business reality and your goals.

Related Posts

Entity structure is just one piece of your overall tax and financial strategy. These guides can help with the bigger picture:

→ Understanding Owner's Draw vs Salary: How to Pay Yourself the Right Way

If you do elect S Corp status, understanding how to pay yourself properly is critical. This guide covers the key considerations.

→ Top 5 Tax Moves for Small Business Owners Before Year End

Entity structure decisions are often best made before year end. This guide covers timing and other strategic tax moves.

→ How to Read a Profit & Loss Statement Like a CEO

Understanding your true profit is essential for evaluating S Corp election. Make sure you're reading your P&L correctly.

→ How to Set Financial Goals for Small Business

Tax strategy should support your broader financial goals. Start with clarity on what you're trying to achieve.

Not Sure if S Corp Makes Sense for Your Tennessee Business?

At Bottomline Capital, we help Tennessee business owners evaluate entity structure decisions in the context of their complete financial picture. We'll run the full numbers, including QBI impact, overhead costs, and compliance requirements, for your specific situation.

📅 Book a Free Consultation to discuss whether S Corp election makes sense for your business.