Conversion is often attractive, but limited liability company owners should think twice about such common pitfalls as having an operating agreement inconsistent with an S election or potential gain recognition.

Although an LLC’s election to be classified as an S corporation for tax purposes can have certain advantages, such as payroll tax savings, there are often significant downsides.

The following are 10 reasons for not electing S corporation tax classification.

1. Many LLC operating agreements contain language that can inadvertently result in the termination of the S election. If the operating agreement’s language is not revised beforehand, the LLC’s Subchapter S election may end up being involuntarily terminated.
2. An S election can result in gain recognition at the time of the election.
3. A new member that contributes property to an LLC that has made an S election may recognize taxable gain as though the property were sold to the LLC.
4. S corporations have no flexibility with respect to allocating items of income and deductions not in proportion to the shareholders’ ownership interests.
5. While a significant advantage of partnership taxation is the ability to include entity-level indebtedness in the partner’s tax basis of his or her interest in the partnership, a shareholder of an S corporation cannot include entity-level indebtedness in the shareholder’s tax basis of his or her stock.
6. While a partnership that distributes appreciated property to a partner generally does not recognize gain, an S corporation’s distributions of appreciated property to a shareholder can result in gain recognition.
7. Unlike the rules for partnerships, there is no provision in Subchapter S that permits the inside tax basis of the corporation’s assets to achieve a step-up in tax basis when a shareholder dies, when a person acquires the stock of a shareholder, or when there is a distribution of property or cash to a shareholder.
8. S corporations have other restrictions, such as a 100-shareholder limit and a rule that corporations and partnerships cannot be shareholders.
9. The one-class-of-stock rule can make it difficult for an S corporation to attract new rounds of investment funds.
10. Tax issues can arise for S corporations in the context of a merger or acquisition, although a possible workaround exists that relies on an F reorganization.

For more details, read the complete article here; The Tax Adviser, or discuss with your CPA.