1.2 Corporations and Limited Liability Companies (LLCs)

Because construction carries substantial financial and safety risks—from latent structural defects and subcontractor defaults to severe jobsite injuries—most commercial and residential builders in Tennessee organize as statutory limited-liability entities rather than sole proprietorships or general partnerships. The two dominant entities that shield owners' personal assets from business obligations are the Corporation and the Limited Liability Company (LLC).

Corporations: Formation, Charter, and Governance

Under the Tennessee Business Corporation Act (T.C.A. § 48-11-101 et seq.), a corporation is an artificial separate legal person created by authority of state law that exists completely separate and apart from the individuals who own and manage it. As a legal person, a corporation holds its own Tennessee contractor's license, enters into contracts in its corporate name, owns real estate and equipment, pays taxes, and can sue or be sued.

• Filing the Corporate Charter (Articles of Incorporation): A domestic Tennessee corporation is formed when one or more incorporators file a Charter (called Articles of Incorporation in many states; Form SS-4417 in Tennessee) with the Tennessee Secretary of State, Division of Business Services, and pay the statutory filing fee. To be valid, the Charter must include: (1) a distinguishable corporate name containing a corporate indicator (Corporation, Incorporated, Company, or Corp., Inc., or Co.); (2) the maximum number of shares of stock the corporation is authorized to issue; (3) the street address and county of the initial Registered Office and the name of the initial Registered Agent in Tennessee; (4) the name and address of each incorporator; (5) the complete street address of the principal executive office; and (6) a statement that the corporation is for-profit.
• Three-Tier Corporate Governance Hierarchy: Unlike a sole proprietorship or partnership where owners manage the business directly, a corporation separates ownership from management through three distinct tiers:
  1. Shareholders (Stockholders): The equity owners who invest capital in exchange for shares of corporate stock. Shareholders do not manage daily construction operations or bind the corporation to contracts merely by owning stock. Instead, shareholders vote at annual or special meetings to elect the Board of Directors and approve fundamental organic changes (such as amending the Charter, merging, selling substantially all corporate assets, or dissolving).
  2. Board of Directors: Elected by the shareholders to exercise high-level oversight, establish corporate policy, approve major credit lines or surety indemnity programs, declare dividends, and appoint and supervise the corporate officers.
  3. Corporate Officers: Appointed by the Board of Directors—typically a President, Vice President, Secretary, and Treasurer—to manage day-to-day construction operations, sign bids and contracts, hire employees, and execute the Board's directives.
• Corporate Bylaws: The internal rules adopted by the incorporators or Board of Directors to govern the corporation's internal affairs (such as notice periods for shareholder and director meetings, quorum requirements, voting procedures, and officer duties). Bylaws are kept in the corporate minute book and are not filed with the Secretary of State.
• Perpetual Existence and Limited Shareholder Liability: A corporation enjoys perpetual existence—its legal life continues unaffected by the death, incapacity, or stock transfer of any shareholder. Shareholders enjoy limited liability: they are generally not liable for entity debts solely by ownership, but their own torts, guaranties, or a successful veil-piercing claim can create additional personal liability.
• Registered Agent and Annual Report Deadlines: Every corporation and LLC registered in Tennessee must continuously maintain a Registered Agent with a physical Tennessee street address to receive service of process. In addition, every corporation and LLC must file an Annual Report with the Tennessee Secretary of State on or before the first day of the fourth month following the end of the entity's fiscal year (by April 1 for calendar-year companies). Failure to file the Annual Report or maintain a Registered Agent results in administrative dissolution, which voids the Active/Good Standing status required to hold or renew a Tennessee contractor's license.

C-Corporations vs. S-Corporations

Every corporation formed under state law is identical from a corporate governance perspective, but the Internal Revenue Code divides corporations into two federal tax classifications: C-Corporations and S-Corporations.

• C-Corporations (Default Corporate Taxation & Double Taxation): By default, a newly formed corporation is taxed under Subchapter C of the Internal Revenue Code (C-Corp). A C-Corp is a separate taxpaying entity that files IRS Form 1120 (U.S. Corporation Income Tax Return) and pays federal corporate income tax (currently a flat 21% rate) on its net taxable profits. C-Corps suffer from double taxation:
  1. First, the corporation pays federal corporate income tax on its net construction earnings on Form 1120.
  2. Second, when the corporation distributes its after-tax profits to shareholders as dividends (reported on Form 1099-DIV), those dividends are not deductible by the corporation, and the shareholders must pay personal federal income tax on the dividend income a second time on their individual Form 1040 returns.
• S-Corporations (Pass-Through Election via IRS Form 2553): To eliminate federal corporate-level double taxation while retaining corporate limited liability, an eligible corporation may elect Subchapter S status by filing IRS Form 2553 (Election by a Small Business Corporation) signed by 100% of its shareholders. To be effective for the current tax year, Form 2553 must be filed with the IRS no later than 2 months and 15 days after the beginning of the tax year (March 15 for a calendar-year corporation), or at any time during the preceding tax year. An S-Corporation generally pays no federal corporate income tax; instead, it files an informational return on IRS Form 1120-S and issues a Schedule K-1 to each shareholder, who reports their pro-rata share of corporate income or loss on their personal Form 1040. Shareholders who perform services for the S-Corp must receive a reasonable W-2 salary subject to FICA and FUTA payroll taxes, while remaining profit distributions pass through without incurring the 15.3% self-employment tax.
• Strict IRS Eligibility Rules for S-Corporations: On the exam, remember that a corporation qualifies for S-Corporation status only if it meets all of the following strict criteria:
  1. It must be a domestic U.S. corporation (or eligible domestic LLC/entity);
  2. It may have a maximum of 100 shareholders (spouses and members of a single family may be treated as one shareholder);
  3. Eligible shareholders are restricted to individuals who are U.S. citizens or resident aliens, estates, and certain qualifying trusts—corporations, partnerships, and nonresident alien individuals are ineligible shareholders. A disregarded LLC may hold shares for its eligible owner; eligibility is tested at the owner level; and
  4. It may have only one class of stock (every share must confer identical rights to distribution and liquidation proceeds, although differences solely in voting rights between voting and non-voting common stock are permitted).

Limited Liability Companies (LLCs)

Under the Tennessee Revised Limited Liability Company Act (T.C.A. § 48-249-101 et seq.), a Limited Liability Company (LLC) is a hybrid statutory entity that combines the corporate liability shield of a corporation with the pass-through taxation and contractual flexibility of a partnership.

• Formation and Operating Agreement: A domestic Tennessee LLC is created by filing Articles of Organization (Form SS-4270) with the Tennessee Secretary of State. The owners of an LLC are called Members (not shareholders or partners). The internal affairs of the LLC—capital contributions, profit and loss allocations, voting rights, and transfer restrictions—are governed by an Operating Agreement.
• Three Management Structures in Tennessee (T.C.A. § 48-249-401): Tennessee is distinctive because its LLC Act authorizes three management structures, which must be specified in the Articles of Organization:
  1. Member-Managed LLC: The default structure; all members participate in management and each member is an agent with authority to bind the LLC in the ordinary course of business.
  2. Manager-Managed LLC: Members appoint one or more designated Managers (who do not have to be members) to control daily operations and sign contracts; non-manager members are passive owners and cannot bind the LLC.
  3. Director-Managed LLC: Management policy is vested in a board of directors with appointed officers handling daily operations, similar to a corporation.
• Federal Tax Classification ("Check-the-Box" Flexibility): The IRS does not treat an LLC as a distinct tax category. Under default rules, a Single-Member LLC owned by an individual is treated as a disregarded entity (reported on the owner's Form 1040 Schedule C and Schedule SE), and a Multi-Member LLC is taxed by default as a partnership (filing Form 1065 and issuing Schedule K-1s). Alternatively, an LLC may file Form 8832 to elect taxation as a C-Corporation or Form 2553 to elect taxation as an S-Corporation.
• Tennessee Franchise and Excise Tax: Regardless of federal pass-through status, corporations (C-Corps and S-Corps), LLCs, and Limited Partnerships operating in Tennessee generally must register with the Tennessee Department of Revenue and pay the annual Tennessee Franchise and Excise Tax (0.25% Franchise Tax on net worth with a $100 minimum, plus 6.5% Excise Tax on Tennessee net earnings) for the privilege of doing business in Tennessee with limited liability.

Foreign Entities and Piercing the Corporate Veil

• Foreign (Out-of-State) Entities: Any corporation or LLC incorporated or organized in another state (e.g., Georgia, Alabama, or Delaware) is classified as a foreign entity in Tennessee. Before bidding or performing construction work in Tennessee, a foreign corporation or LLC must obtain a Certificate of Authority from the Tennessee Secretary of State and designate a Tennessee Registered Agent.
• Piercing the Corporate Veil: The limited liability shield of a corporation or LLC is not absolute. Tennessee courts will pierce the corporate veil—stripping away the entity shield and holding shareholders or LLC members personally liable—when owners fail to treat the entity as a separate legal person. Key factors that trigger veil piercing include: (1) commingling personal and corporate funds (paying personal mortgages or groceries directly from the company checking account or depositing job checks into personal accounts); (2) undercapitalization (operating a shell company with inadequate capital or insurance to meet foreseeable liabilities); (3) ignoring corporate formalities (failing to keep separate books, failing to hold required meetings or keep minutes, or signing contracts without showing corporate/LLC capacity); and (4) fraud or injustice. In addition, owners remain personally liable whenever they sign a personal guaranty on a bank loan, surety bond indemnity agreement, or Tennessee Board Guaranty Agreement.

Limited liability does not shield an owner from personal negligence or a voluntarily signed guaranty. Tennessee franchise and excise exemptions include qualifying obligated-member entities and other statutory categories; federal pass-through treatment alone does not establish a state exemption. The excise standard deduction and other tax adjustments must be applied before calculating tax.