Discussion:"Check the Box" LLC argument revisited

It's less paperwork than doing corporate resolutions, minutes, etc.

Of course I wouldn't do this if the S-corp would hold appreciating assets, etc. but other than that it seems like a no brainer. Am I missing something?

Thanks for the input.

The amount of paperwork involved for an MMLLC to achieve the same level of liability protection and basic functionality that a straight S election would is far under-estimated. $3000 to start for an MMLLC agreement in my area if there are real capital and revenue interests involved. A solid corp by-laws book and some nice looking certificates and you are out the door for $1k.

An SMLLC is a great entity for sole p's looking for protection and the question would be why file the 2553 at all?

William Price, EA | Portland, OR - Talk to me

Hey JR1 - what is this about minutes??? ;)

Many people would be better off with the LLC disregarded, but if your heart is set on an S corporation, the LLC is still the best way to get there.

Is there new evidence to the contrary?

Also, can't some net income in an S Corp be saved from Payroll Tax (after paying reasonable comp.)

A lot of adivosrs recommed S corps over LLC's bc of the SET games and since there are less state law corporaet formalities with a state law LLC. In certain cases, I agree that an S corp is a better vehicle for these reasons.

The need for flexiblity (capital influx, dispropotinate allocations, dispprportionate distributons, a wider universe of investors) though typically causes me to recommend an LLC taxed as a partnership/sole prop.

The big issue that I have seen, though, that should keep you up at night is where a client comes in with an exisiting LLC and asks for tax planning based upon business needs. Suppose the LLC represeantive says that they want to (1) let in "C Corp" as an investor, (2) let in a new investor and give it a pref, or (3) give an interest to a trust (that would not be able to elect ESBT or QSST, etc) and due to thinking you are dealing with an LLC, you adivse the client about the alternatives and then the client proceeds with the planning. If an S corp election has been made for the LLC, any of the aforementioned items (or any number of other items) would terminate the S election. Viola', now you've got a client expecting flow though treatment that is immediatley a shareholder in a C corp. THat's right. You cannot "revert" to LLC status. Rather, you are a C corp and cannot re-elect S status for five years. I've not seen any reported guidance re: the IRS granting releife for an inadvertant termination due to these facts based upon a miscommunication between the advisor and client but I expect that a lot of requests have been submitted.

My nutshell:

1. The 2 step or 3 step S corp election for an LLC may be good in certain circumstances but the entity may unduly restrict itself by doing so.
2. If you are an advisor, make sure that your LLC clients have not elected S corp status. Get such a rep in writing.
3. If you are an LLC having made an S election, please tell your adivsor of this even if your adivsor doesn't ask.

If you have an LLC that has elected to be an S corp, you need to treat everything just like it were an S corp. Prorats distributions, prorata allocations, no funky equity, no funky debt, no nonqualified investors.

On making the election, pay close attention to Sec. 357(c) ---> "gain on a Sec. 351 transaction if the debt assumed by the corp exceeds the tax basis of property contributed"

WIth real estate, since it can appreciate at such a great clip, the real estate cannot get "out" of the S corp in a tax efficent manner. The S corp will be deemed to have sold it to the shareholder at FMV thereby causing gain at the entity level withc flows through to the sahreholder. While the flow through increases basis, there will still be tax to pay. While this is better than a C corp bc C corps would have two layers of tax (entity and sharehodler), it is far worse than that which could be accomplished in a LLC taxed as a paretnerhsip (carryover basis no gain recognition in many cases).

....I edited this in order to correct my post...

Thanks, Mike

Once an LLC has elected to be taxed as other than the default, there is a 5 year waiting period to elect another tax scheme. So if a MMLLC, whose default is a 1065 chooses to be taxed as an 1120-s, then it must wait 5 years before going to either 1120 or 1120s (or even Sch C if all members but one dropped out). Accepting the default classification is not considered to be an election, so there is no 5 year waiting period to change from default to something else.

I don't know which two-step they do in Wisconsin. Maybe he is referring to the prior 8832 Corp election, then the 2553 S-corp election, which was changed in 2004 to now only require a 2553 (per the instructions).

Got out my text from when I taught this several times last year. LLC has to be an "eligible entity". An eligible entity is any entity recognized for federal tax purposes that is not properly classified as a corporation or otherwise subject to special treatment under the tax code (insurance company, bank, etc).

2) Read the Form 8832 instructions on the 60 month rule on page 5 of the Instructions

A partnership filing Form 1065 would have to convert to a C corporation by state law first, though, so your comment is a little puzzling. It would have a 3 step process.

Could someone please let me know if my understanding of the mechanics of the check the box election and the ability to revert is correct?

Facts: Client forms a new SMLLC and using the form 2553 elects to be treated as an S-Corp (S-Election to be effective same date as LLC formation). Client reverts back to SMLLC 14 months later.

Questions:
1) Am I correct that only the Form 2553 need be filed (no 8832)? Simply file form 2553 Part I in the same way that one would file form 2553 for a newly formed C-Corp electing to be treated like an S-Corp?

2) Am I correct that because the S-Election was originally made by a newly formed eligible entity and was effective on the date of formation, that the 60 month rule does not apply and taxpayer can revert back to SMLLC immediately (see form 8832 instructions and Reg. 7701-3(c)(1)(iv).)?

Am I correct that to effectuate this reversion, taxpayer should file form 8832 as follows:

• Check box 1(b) “Change in Current Classification”
• Check box 2(a) “YES”
• Check box 2(b) “YES”
• Check box 3 “NO”
• Complete Lines 4a & 4b
• Skip Line 5
• Check box 6(c)

Concerns:

• Is it correct to file the 8832 to revert back to a SMLLC eventhough the election to be classified as a corporation/s-corporation was made originally on the 2553?

I discussed these mechanics with a tax attorney and he admitted that he had not seen this in practice but suggested that instead of filing only the form 2553 election (to elect to be classified as a corporation/s-corporation for federal tax purposes), that initially, the taxpayer should take the two step process and also file the form 8832 to avail themselves to the exception to the 60 day rule that is addressed under the 8832 rules.

Any thoughts, suggestions or heated discussions on the topic would be greatly appreciated!

My biggest concern is when one files a Form 2553 to make the election is it appropriate to file the form 8832 to revert? And if it is appropriate or not, is it advised to file an 8832 to elect to be treated as a corp anyway simply to avail oneself to the 8832 exception to the 60 day rule.