S corporations and LLCs with S corporation elections provide similar liability protection and federal tax treatment, passing income through to owners. However, S corporations pay annual franchise taxes that LLCs are not subject to. Both entity types allow for distributions to owners to avoid self-employment taxes. An LLC can also elect partnership tax treatment to defer taxes until cost basis is exceeded and allow tax allocations between partners. Due diligence for mergers examines ownership verification, and the acquisition may provide an opportunity to change the entity type for future tax advantages.

1. What advantages and disadvantages are there to Illinois S corporations and
LLCs with an S Corporation Election?
By: William A. Price, Attorney at Law, www.growthlaw.com
Both S corporations and limited liability companies (LLC’s) are generally similarly
treated in Illinois for liability and tax purposes, particularly if an S corporation election
is in effect for the LLC. Internal organization statutes are different. What is similar is
that there is liability limitation to investment in either type of entity, similar veil
piercing doctrines, an identical state personal property replacement tax rate of 1.5%,
and general federal passthrough income tax treatment (no entity level tax usually
assessed, depends on net income, all reported to and payable by owners) for both a
sub S and an LLC treated as an S corporation. Differences include:
State business organization fees/taxes on capital:
S corporation:
– Initial state organization/foreign state application for recognition to do business fee
$150 plus at least $25 franchise tax, annual report $75 plus at least $25 franchise tax,
that tax is 1/10 of 1% on paid-in capital (max. tax $2 million). Franchise tax
calculation example, see:
http://tax.illinois.gov/aboutidor/taxresearch/IllinoisCorporateFranchiseTax_HJCRF
SG_03-21-2014.pdf
LLC:
– Initial state organization/foreign state application for registration to do business fee
$500, annual report fee $250, no franchise tax.

2. Federal Income Tax:
S corporation/LLC with S election:
–Both are identically treated under federal income tax rules. Makes payment of
distributions for non personal services entities paid to owners as dividends easier to
treat as other than employment revenue, so not subject to self-employment Social
Security/Medicare tax of 3.5%.
Partnership, Not S Corporation LLC:
In evaluating whether to make the S election, if the Social Security/Medicaid tax is not
the prime issue, passthrough treatment is in any case automatic for LLC’s unless
another election is made. Note that partnership tax treatment for the LLC, instead of
S corporation treatment, provides for no taxable income until cost basis of entity
ownership (cash plus property contributed plus entity debt assumed) is exceeded, and
partners can allocate tax responsibilities to each other by agreement.
Agency Authority:
S corporation:
President of the corporation has apparent authority to contract for the entity.
LLC taxed as S:
Apparent authority to contract for all managers in manager-managed entity, for all
members in member-managed.
Current Developments:
I chaired the subcommittee that wrote both versions of the LLC Act as passed to
date. Changes based on the new Revised Uniform Limited Liability Companies Act
may be introduced next year, after review by the Institute for Illinois Business Laws
(IIBL) and other legal and business organizations. This should add further flexibility
and clarity to LLC rules and standards for organization or registration of same in
Illinois.
Application To Mergers, Acquisitions, and Recapitalization:

3. Due diligence on a merger usually involves verification of ownership by the seller,
which requires examination of the “corporate book” for the entity (all official filings
and all internal management minutes or resolutions or ownership issuance documents
and agreements that changed and established ownership interests). The specific
requirements for valid changes vary by entity. Tax payments warranties differ for
pass-through and non pass through entities, as do the net tax exposures, so work with
accountants to make sure all required tax payments have been made. The acquisition
may also be a good opportunity to change the type of entity for future operations to
one less exposed to income, sales, personal property, Social Security/Medicare, and
other taxes or liabilities than the current organization. Some states, like Wyoming, lack
entity income taxes. Some, like Oregon, have no sales taxes. Others, like Alaska and
Delaware, have “asset protection” business trust options, with or without any local tax
on income earned out of state. A good mergers and acquisitions lawyer can help with
appropriate tax and liability exposure analysis and entity reorganization to meet the
future domestic and foreign state entity needs of the merged business.