There are situations when it is advantageous to elect S corporation status for a limited liability company. In a future post I will address the pros and cons of partnership taxation versus S corporation taxation.
For those LLCs that elect S corporation status it is of critical importance that the operating agreement not create a second class of stock. More than one class of stock will destroy an entity's S corporation status.
An LLC will be treated as having only one class of "stock" so long as the governing provisions of the LLC (primarily the articles of organization/certificate of organization and the operating agreement) provide that all of the outstanding membership interests/transferable interests "confer identical rights to distribution and liquidation proceeds." Lackadaisical drafting of the operating agreement or over reliance on forms can lead to unfortunate results in this regard.
At least one respected commentator believes he has yet to see an operating agreement that does not violate the second class of stock rule. However, there is at least one IRS Private Letter Ruling that did find the operating agreement satisfied the requirement. See PLR 200548021 (August 23, 2005). The drafting was no doubt precise and the provisions related to distributions and liquidations tied closely to S corporation requirements.
-Marc Ward
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