Limited Liability Companies as S Corporations?
You might ask: Why do this? Maybe the answer is: just because you can. It is clearly possible for a state law limited liability company to elect to be taxed as a corporation and then make an S corporation election (if the entity otherwise qualifies to make such an election). The question is--why?
The explanation has to lie with applicable state law. Possible state law law explanations include:
- The applicable state limited liability company statute is more favorable than the applicable state corporate statute.
- Perhaps, for example, because the state law on limiting the liability of the managers of the LLC is more favorable than the state law limiting the liability of directors and officers of the corporation.
- Or perhaps because the state law with respect to the governance of the LLC is more favorable than the state law with respect to the governance of the corporation.
In the author's opinion, whatever is to be gained in these regards is overshadowed by the complexity of the set up, and the confusion that it is likely to generate in future due diligence questions. In most if not all cases the author believes that this choice of entity is likely to be more trouble than it is worth.
The applicable state limited liability company statute is more favorable than the applicable state corporate statute, that is the best value of this.
The problem is the undue complexity. I don't think state LLC statutes are worth it. Plus, this is easy to screw up. I just was looking at one of these and the LLC Agreement of the "S Corp" had a bunch of partnership tax provisions in it, including liquidation provisions in accordance with capital accounts. Those provisions might have been a bust of the S corp status because they might have created a second class of stock...again, its a judgment, but in mine, probably not worth the effort.
What if you had a jurisdiction like the District of Columbia that disregards S corp status and treats S corps like C corps for income tax purposes? If the LLC elected S corp treatment, could it have the federal benefits it seeks from such treatment, but continue to be taxed in DC as the LLC it was formed as, i.e., taxed as a partnership? I think not, and that the S corp election would have the effect of making the LLC taxed as regular C corp in DC.
David, I think that the local jurisdiction treatment should not affect the federal treatment. So you could still have an LLC taxed as an S corp at the federal level, but taxed as a C corp at the local level.
Thanks, Joe. But would the federal election affect the local level? DC defines "corporations" as including S corps, so I guess my theory would have to preclude the notion that the LLC changes into something else locally when it becomes a S corp federally.