LLC vs S-Corp — Which Is Right for Your Tennessee Business?

"Should I elect S-Corp?" We get this question at least once a week at our Jackson office. Usually because someone watched a YouTube video that promised massive tax savings. And look — S-Corp can save you money in the right situation. But for most Tennessee small business owners, an LLC is the better choice. Let us explain why.

First, Let's Clear Up a Common Confusion

An LLC is a legal structure. An S-Corp is a tax election. They're not the same kind of thing, even though people compare them like they are.

You form an LLC with the state (which protects your personal assets from business debts). Then you choose how it's taxed. By default, a single-member LLC is taxed as a sole proprietorship. But you can elect to have it taxed as an S-Corp. It's still an LLC legally — it's just taxed differently.

The S-Corp Pitch: Self-Employment Tax Savings

Here's the argument you've probably heard. As a standard LLC, you pay self-employment tax (15.3%) on all of your net business profit. Elect S-Corp, pay yourself a reasonable salary, and only the salary is subject to payroll taxes. The rest comes to you as a distribution with no self-employment tax.

On paper, that sounds great. And the YouTube videos stop right there. But that's not the whole story — especially in Tennessee.

What the YouTube Videos Don't Tell You

1You're Still Paying Payroll Tax on Your Salary

The S-Corp doesn't eliminate self-employment tax — it just shifts it. When you pay yourself a reasonable salary, you're withholding and matching FICA taxes (Social Security and Medicare) just like any employer would. That means you're effectively paying self-employment tax on that salary — it's just split between the "employee" half you withhold and the "employer" half the S-Corp pays. The IRS requires that salary to be "reasonable" for your role, and they absolutely audit this. Set it too low to dodge taxes and you're inviting trouble. The actual savings are often smaller than people expect once you're paying yourself what you should be. This is the variable that YouTube and TikTok videos conveniently leave out when praising S-Corps.

2Tennessee Franchise and Excise Tax

This is the big one for Tennessee business owners. Tennessee imposes a franchise and excise tax on S-Corps and LLCs taxed as S-Corps. The excise tax is 6.5% of net earnings not subject to self-employment tax, after the first $50,000 (which is exempt). A standard LLC sole proprietor doesn't pay this — though LLCs do still pay the minimum $100 franchise tax.

So while you might save some self-employment tax on one hand, you're picking up that 6.5% excise tax on the other (after the $50k exemption). Depending on your income level, the excise tax can eat up most or all of your S-Corp savings. You have to run the actual numbers to know.

3Basis and Loss Limitations

With a standard LLC, your basis (which determines how much in losses you can deduct) includes your share of the company's liabilities, including loans. With an S-Corp, your basis does NOT include company debt unless you personally loaned money to the S-Corp. This means S-Corp owners can run into situations where they can't deduct losses they should be able to deduct. If your business is still growing, has debt, or might have a down year, this matters.

4The QBI Deduction Gets More Complicated

The Qualified Business Income (QBI) deduction allows eligible business owners to deduct up to 20% of qualified business income. With an S-Corp, the salary you pay yourself is NOT qualified business income — only the distribution portion qualifies. This can reduce your QBI deduction compared to what you'd get as a standard LLC. For some business owners, the QBI impact actually offsets the self-employment tax savings.

5More Paperwork, More Cost, More Rules

An S-Corp requires you to run payroll (which costs money), file quarterly payroll tax returns, file a separate S-Corp tax return (Form 1120-S) in addition to your personal return, and follow corporate governance requirements like maintaining meeting minutes and records. All of this costs time and money that a simple LLC doesn't require.

When S-Corp DOES Make Sense

We're not saying S-Corp is never the right call. For some of our clients, it absolutely is. Interestingly, S-Corp tends to work best for Tennessee business owners in what we'd call the "sweet spot" — typically those earning under $150,000 or so. At this level, the self-employment tax savings can meaningfully outweigh the 6.5% excise tax.

Once business owners start making significantly more money, the math often flips. Higher earners frequently find that staying as a standard LLC actually works better for their situation (though there are always exceptions). Factors like the QBI deduction phase-outs, the flat 6.5% excise tax rate, and other planning strategies can make the LLC more advantageous at higher income levels.

The S-Corp election tends to work well when your business is generating consistent profit above a reasonable salary (but not so much that the excise tax overwhelms the savings), you've already maxed out your QBI deduction or it doesn't apply to your situation, you don't have significant business debt that you need in your basis, and the self-employment tax savings clearly outweigh the Tennessee excise tax.

But notice how many conditions are in that paragraph. It's not a simple yes-or-no answer, and anyone who tells you otherwise is oversimplifying.

Our Typical Recommendation

For the vast majority of our Tennessee clients, we recommend starting as a standard LLC. It's simpler, cheaper to maintain, more flexible with basis and losses, preserves your full QBI deduction, and avoids the franchise and excise tax.

Then, as your business grows and your income changes, we revisit the question every year. If and when the math clearly favors an S-Corp election for your specific situation, we'll tell you. That's the kind of analysis a CPA does — not a one-size-fits-all recommendation, but a personalized answer based on your actual numbers.

Don't make this decision based on a blog post or a YouTube video. The right entity structure depends on your specific income, Tennessee tax exposure, debt situation, QBI eligibility, and long-term goals. It's one of the most valuable conversations you can have with a CPA, and it's one we have with every new business client who walks through our door.

Ready to figure out the right structure for your business? Book a free consultation or learn more about our entity selection services.