Corporations electing subchapter S tax treatment were originally designed to pass corporate income, losses, deductions, and credits through to the owners of small corporations. S corporations must limit the number of shareholders to 100 and can only have one class of stock (although there may be voting and nonvoting common stock), imposing restrictions on the ability to allocate profits and losses amongst the various shareholders. The subchapter S requirements also place restrictions on the status of the individual and type of entity that may become a shareholder in an S corporation. For example, 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. This is a significant point of difference for many business owners starting new businesses in South Carolina.

By contrast, there are no special restrictions on the number of individuals or types of entities which may own membership interest in an limited liability company (LLC) electing partnership tax treatment. Note, an LLC may also elect subchapter S tax treatment in certain circumstances. (Foreign investors will find that the LLC is similar to the German GmbH, the French SARL, and the Central American Limitada). The LLC enjoys much greater flexibility in allocating items of profits, losses, income and deductions.

Contributions of Property

LLC members that contribute property to an LLC must be allocated the built-in gain or built-in loss attributable to the contributed property. No comparable provision exits in the subchapter S regulations.

Allocations of Income and Losses

As noted above, S corporations may only have one class of stock, effectively preventing it from making special allocations of the corporate income and losses. An LLC, by contrast, may allocate the income and losses to its members in disproportionate ratios in special circumstances. Thus, LLC members are allowed greater flexibility in allocating the LLC’s items of income, gain, losses and deductions. While S corporations also pass items of income, gain, losses and deductions to its shareholders, S corporation shareholders must report these items proportionately according to their ownership in the corporate stock.

Amount of Loss Deduction

LLC members also have a much greater opportunity than S corporation shareholders to deduct the businesses losses. The IRS Code limits the deductibility of losses for both shareholders of S corporations and LLC members to their basis in the stock or membership interests.


A distribution of cash to members of an LLC will not result in taxable gain to the member unless the cash exceeds his or her outside basis in the LLC. The LLC generally will not recognize a gain or loss upon a distribution of cash or other property to a member unless there is a deemed sale of unrealized receivables or substantially appreciated inventory.

Distributions of cash or other property by an S corporation to its shareholder is nontaxable to the shareholder to the extent of his or her basis in the stock. An S corporation will, however, recognize gain upon the distribution of appreciated property to a shareholder.

Liquidation of Business

The tax treatment of the owners upon the liquidation of an S corporation and a limited liability company is different. Under partnership rules, liquidations can generally be accomplished tax free. Tax liability may arise when the amount of cash distributed to the member exceeds the member’s basis for his or her interest or when unrealized receivables or inventory items (hot assets) are distributed.