For the umpteen time today a client told me about the client’s discussion with a person who does not understand the difference between the type of entity formed under the law of one of the fifty states vs. the method of income tax applied to the entity by the Internal Revenue Code of 1986, as amended. The ignoramus said, “My company insists that it enter into a contract with your company, but only if your company is an S corp.” My client’s company is an LLC, but the ignorant person thinks his company cannot enter into a contract with the LLC because the LLC is not an “S corporation.”
Too many people, including CPAs and lawyers, do not understand that when they say the entity must be an S corporation they are mixing two concepts: (i) the type of entity formed under state law, and (ii) the income tax method applicable to the entity under the Internal Revenue Code. Just today I downloaded the materials to a webinar I will watch later today. The lawyer who is teaching the webinar created reference materials that constantly use the phrase “limited liability companies vs. ‘S’ corporation.” The lawyer knows better, but falls into the trap of loose talk about S corporations.
Not one single state in the United States allows people to create an S corporation. The states allow people to create, sole proprietorships, general partnerships, limited partnerships, limited liability partnerships, limited liability limited partnerships, for profit corporations, nonprofit corporations, benefit corporations, and limited liability companies. The term “S corporation” refers to a method of federal income tax applicable to an entity under the Internal Revenue Code. After forming your entity under state law you must then decide the federal income tax method you want to apply to your entity. If Homer Simpson forms a for profit corporation in Arizona and an Arizona LLC, he can cause both entities to be taxed under Subchapter S of the Internal Revenue Code by timely filing an IRS form 2553. The federal income tax law applies exactly the same to the corporation and the LLC taxed as S corporations.
P.S. Timely filing the IRS Form 2553 means filing the form with the IRS within the first two and one half months of the entity’s existence or within the first two and one half months after the beginning of a calendar year.
For more on this topic see my article called “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?“