Actually the problem lies with the requirements of the Subchapter S Corporation and the type of business and format of the LLC.
In order for the company to become and/or remain an S-Corp, ther are some very specific limitations.
(1) The company must be a domestic corporation
(2) It must be a 'small business' corporation
(3) There can be no more than 100 shareholders of the company.
(4) There can be only one class of stock.
(5) Shareholders of S corporations must be individuals except as provided elsewhere in the code governing the establishment of the S-Corp
(6) None of the individual shareholders may be a non-resident aliens.
(7) Exceptions to shareholders being individuals include:
Certain Trusts - listed in the code
Corporations - except as follows:
A) a Bank
B) an insurance company
C) a corporation to which an election related to Puerto Rico Tax Credit applies
If the LLC meets all of the above requirements for being a shareholder, then it can be the sole shareholder of the S-Corp.
As far as tax-free treatment of the transaction
, the purchase of the stock by the LLC would be tax-free to the LLC, but the sale of the stock by the shareholders of the S-Corp would fall under the regulations concerning Sale of Investments and Capital Gains.
This transaction must be at 'arms-length' in order to ensure that it is treated equitably should an audit occur. Therfore, everything must be at fair market value and all paperwork drawn up as though the S-Corp were selling it's stock to a new owner who wasn't originally an owner of the company in the first place.