Property Distributions in S-Corporations v. LLCs & Taxes

Although S-corporations and LLCs that elect partnership tax treatment are often thought to be very similar in terms of taxation, i.e. they allow pass-through taxation in which the entity itself is not taxed, there are a number of important taxation-related differences between them because they are not taxed under the same provisions of the Internal Revenue Code (LLCs may be taxed as partnerships under Subchapter K of the Internal Revenue Code while S-corporations are taxed under Subchapter S, hence the name "S-corporation").

Entity-Level Recognition of Gain & Loss

One important difference between S-corporations and LLCs is whether gain or loss must be recognized at the entity level when property is distributed to shareholders/members.

S-Corporations

When property is distributed to S-corporation shareholders, the corporation must recognize any gain or loss associated with the property. Any gain is then passed through to the shareholders. 26 U.S.C. §1368(b).

LLCs

In contrast, most distributions of property by an LLC that is taxed as a partnership, do not require the LLC to recognize gain or loss on the distribution. 26 U.S.C. §731(a)(1).

Shareholder / Member-Level Recognition of Gain & Loss

Another important difference between S-corporations and LLCs is whether the shareholders/members themselves must recognize gain and loss on distributions.

S-Corporations

Because S-corporations must recognize gain or loss on the distribution of property to a shareholder, all the individual shareholders, even those shareholders who do not receive the property distribution, must recognize gain or loss on the distribution of the property and will be taxed accordingly.

LLCs

Because an LLC, generally, does not recognize gain or loss on distributions of property, the individual LLC members who do not receive the distributed property usually need not recognize the gain or loss associated with the distribution. However, the member who receives the distribution of property may or may not recognize gain or loss on the receipt of property depending upon the type of property distributed and the recipient member's cost basis in his or her LLC interest.

This brief overview of some important considerations associated with the taxation of Subchapter-S corporations and limited liability companies (LLCs) is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

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