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Focus on the Law: Business Associations in Tennessee

By Sharon Frankenberg

If you are considering forming a new business, there are many things to consider.  Here are some highlights of the major forms of business associations in Tennessee.  The most familiar to many of us is the sole proprietorship.  This is how most small businesses start out. One person owns the firm and is responsible for the day-to-day operations.  All of the business assets are owned by one person. The owner has all of the responsibilities for liabilities owed by the business.  The sole proprietor pays tax on the net income from his or her business and it is taxed at the rate for regular income.  The net income from the sole proprietor’s business is usually filed on a Schedule C with their regular 1040 personal income tax form.  With a few exceptions, sole proprietors need a business license from the city and county where their business operates.  The primary benefit of a sole proprietorship is that it is simple and relatively inexpensive to operate. The biggest negative is that there is no protection from personal liability from lawsuits.

A second form of business association is the partnership.  Partnerships involve more than one person.  These people need not be related even though husband and wife partnerships are quite common. The contributions and responsibilities of each party should be agreed upon in advance and included in a written partnership agreement.  The best practice would be to have this agreement drafted by an attorney. The partnership will also have to file an information tax return every year with the IRS but the income (or loss) from the partnership’s business is passed through and taxed to its partners. Like in a proprietorship, in a general partnership like this there is no protection from personal liability.

Corporations are formed when groups of investors get together to start a business.  The corporation is considered a legal “person” and may own assets and conduct business in the name of the corporation.  The corporate form protects individual shareholders from personal liability.  Standard corporations are usually formed as C Corporations and typically have large numbers of shareholders.  They must have a board of directors and corporate officers and hold regular board meetings.  Minutes must be kept of these meetings and records made of any resolutions approved by the board.  Corporations pay federal taxes at a higher rate than sole proprietorships. Corporations must also pay franchise and excise taxes to the state.

Some businesses are eligible domestic corporations which qualify to form an S Corporation under the rules of Subchapter S of the Internal Revenue Code. These corporations typically have no more than 35 shareholders. S corporations have to pay state franchise and excise taxes but may avoid the double federal taxation on corporations.  Standard C corporations pay federal tax on profits made by the corporation and the shareholders also pay federal income tax on income they receive from the corporation.  The S corporation passes its income and losses through to its shareholders for inclusion on their separate returns.

The last form of business association I will mention here is the Limited Liability Company (LLC.)  LLCs are a fairly new business form in Tennessee.  They combine the personal liability protection of a corporation with the tax benefits of a partnership.  LLC income passes through to the owners of the LLC who are called “members.”  Members can be individuals, partnerships, corporations, other LLCs and foreign entities.  There can also be single member LLCs with only one owner.  LLCs must file annual reports and pay fees to the state which range from $300-$3,000 per year.

Choosing the form of your new business or changing the form of your existing business is a critical decision.  Make sure that you get the best professional help possible to ensure your future success.

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