LLC Versus S Corporation Overview
For more than a decade, our Chicago business attorneys have advised business and corporate clients on the distinct differences between an Illinois limited liability company and Illinois corporations electing to be taxed as S corporations from both tax and business standpoints. Deciding between starting an LLC or incorporating an S corporation to conduct a business is generally decided on whether a flow-through tax treatment is desired. In general, flow-through tax treatment means that the business entity itself is not subject to tax. Rather, the owners of the business will report their shares of the business’ income, gains, losses, deductions, and credits on their own tax returns.
Although an LLC and an S corporation may provide the desired flow-through tax treatment, an LLC is generally taxed as a partnership under Subchapter K, while an S corporation is taxed under Subchapter S. These tax elections are not the same.
It should be also understood that an Illinois limited liability company may elect to be taxed under Subchapter S.
S Corporation Business Owners
Probably the most significant difference between a limited liability company and an S corporation is the restriction on who can be a shareholder of an S corporation. Only individuals other than nonresident aliens, grantor trusts, qualified Subchapter S trusts, electing small business trusts, certain estates, qualified retirement plans, and charitable organizations can be shareholders of an S corporation. Thus, an S corporation cannot have as a shareholder a nonresident alien, a corporation, a partnership, a limited liability company, or a non-qualifying trust. For LLCs, no such restriction exists. Any individual or entity can be a member of an LLC.
Business Income and Business Losses
Another difference between an LLC versus S corp is the allocation of the business’ income and losses among the owners. An LLC, which is most often taxed as a partnership, is subject to the allocation rules of Internal Revenue Code §704(b). That section generally allows any allocation of income and loss among the members as long as the allocation has substantial economic effect. For example, members who provide capital to the business can be provided a preferential return, similar to interest. Allocations among members may be determined at the end of the year based on the LLC’s operating results and may also vary from year to year. Likewise, distributions to the members may be flexible. For example, members providing capital may receive a return of their capital before any distributions are made to members who do not.