So the Dog Ate Your S-Corp Election? The IRS Might be Willing to
Throw You a Bone
By Craig Pendarvis,
Esq.
PricewaterhouseCoopers LLP, Washington, DC
Mr. Pendarvis is a senior associate with the Washington National
Tax Office of PricewaterhouseCoopers LLP. He has a B.A. from the
University of Washington (Seattle), a J.D. from the University of
South Carolina School of Law, and an LL.M. in Taxation from
Northwestern University.
Failing to make a timely S corporation election used to result in
devastating consequences for the electing S corporation and its
shareholders, with little or no practical recourse. Obtaining desired
S corporation status could easily be missed by inadvertently not
making a timely election for any number of day-to-day reasons. Now,
through a series of revenue procedures, the IRS has made it fairly
easy to correct untimely (or erroneous) S corporation elections. This
does not mean tax practitioners should be any less diligent in
assisting their clients in making S corporation elections, but if
clients fail to follow instructions, the consequences are not quite as
dire as they were in the past.
Section 1362(b)(1) requires that an election to be treated as an S
corporation be filed at any time during the taxable year preceding the
year in which the taxpayer intends it to be effective, or during the
first two months and fifteen days of the taxable year for which it is
intended. In the event that an election is filed after such time, the
election will be treated as made for the following taxable
year.1 The purpose of this
statutorily imposed deadline to file the S corporation election is to
foreclose retroactive tax planning using the S corporation
election.2
Congress enacted §1362(b)(5) as part of the Small Business Job
Protection Act of 1996.3 This
provision grants the IRS the authority to treat late elections as if
they were timely filed provided that: (i) an election was filed after
the date prescribed by §1362(b)(1); and (ii) the Secretary
determines that there was reasonable cause for the failure to make a
timely election. In this provision, Congress intended that the IRS
would apply the same standards in determining if there was reasonable
cause for the failure to make a timely election as applied in
determining whether a subchapter S termination was
inadvertent.4 In response to
Congress' enactment of §1362(b)(5), the IRS has issued a series
of superseding Revenue Procedures which taxpayers may use to seek
relief for S corporation elections that have been filed after the due
date.5
In Rev. Proc. 2003-43, the IRS provided a simplified procedure by
which S corporations, could request relief for an untimely filed
election.6 For S corporations
to obtain relief, the revenue procedure distinguishes between whether
or not a tax return has been filed for the first tax year of the
intended election under subchapter S. If the corporation has not yet
filed a tax return, an S corporation election must be filed within 18
months of the original due date of the intended election (but in no
event any later than 6 months after the due date of the tax return,
excluding extensions, of the corporation's tax
return).7 For example, if a
calendar year S corporation's election was intended to be filed no
later than March 15, 2008, but was not and no income tax return had
been filed for the 2008 tax year, then a late S corporation election
can be made as late as September 15, 2009.
On the other hand, if the intended S corporation has already filed
a tax return for the intended election year, the S corporation
election must be filed within 24 months of the original due date of
the election.8 So using the
example above but assuming an income tax return was filed, the late S
election would need to be filed no later than March 15, 2010. The IRS
appears to be more lenient in situations where a tax return has been
filed because in these situations they may have failed to notify the
corporation that the IRS records are inconsistent with the type income
tax return filed on behalf of the corporation.
In either case, the revenue procedure requires that the corporation
demonstrate reasonable cause (as determined by the IRS) for its
failure to make a timely election. Furthermore, all taxpayers whose
tax liability or tax returns would be affected by the election
(including shareholders of the corporation) must have taken positions
consistent with the election in the year of the intended election and
any subsequent years.9
To further simplify the process for obtaining relief for untimely S
corporation elections, the IRS has supplemented Rev. Proc. 2003-43
with Rev. Proc. 2007-62, which allows for corporations which have not
already filed their tax returns for the year in which the election was
intended to be effective to file their Form 1120S along with a request
for relief for failure to timely file an election. The taxpayer can
simply attach Form 2553, along with a reasonable cause statement
explaining the untimely election, to the Form 1120S. If a taxpayer is
ineligible to obtain automatic relief under Rev. Procs. 2003-43 and
2007-62, they may seek relief from the IRS through the private letter
ruling process.
It appears that the IRS has been willing to exercise its
discretionary authority to grant relief in favor of the
taxpayer.10 Unfortunately, it
is difficult to ascertain what the IRS will determine to be reasonable
cause or inadvertence when it comes to a late filing. To date the IRS
has not publicly provided criteria they use to judge what is
reasonable cause or inadvertence. Where the IRS has granted relief,
either through an information notice or through a letter ruling, they
have done so without a public explanation as to what factors they used
to reach such a determination. Therefore, while the number of times
that the IRS has granted relief for taxpayers suggest that the IRS
applies a fairly liberal standard in determining whether a late filing
is reasonable or inadvertent, it is unclear what exactly constitutes
such.
Taxpayers and practitioners are able to take some comfort in the
IRS’s willingness to take a taxpayer favorable position when it
comes to granting relief for a failure to timely file an S corporation
election. As a matter of practice, it needs to be emphasized that
§1362(b)(5) and Rev. Procs. 2003-43 and 2007-62 are relief
provisions, and not statutory or regulatory grants of an extension to
file. One should always plan to file on time and never count on the
IRS’ willingness to exercise its discretion favorably.
Furthermore, when relief is needed, the taxpayer or practitioner needs
to be sure than any representations made to the IRS are accurate.
However, in the unfortunate situation where an election has not been
timely made, taxpayers and practitioners should be aware that relief
is available, and the IRS seems to be taxpayer considerate in granting
such relief.
For more information, in the Tax Management Portfolios, see
Starr, 730 T.M., S Corporations: Formation and Termination, and
in Tax Practice Series, see ¶4240, Making an S Election.
1
§1362(b)(3).
2
See S. Rep. No. 797, 95th Cong., 2d Sess. 7, reprinted in 1978-2 CB 439, 443.
3
P.L. 104-188.
4
H.R. Conf. Rep. 104-737, 104th Cong., 2nd Sess. 221.
5
See Rev. Proc. 97-40, 1997-2 C.B. 48, superseded by Rev. Proc. 98-55, 1998-46 I.R.B. 27, superseded by Rev. Proc. 2003-43, 2003-23 I.R.B. 998, supplemented by Rev. Proc. 2007-62, 2007-41 I.R.B. 786.
6
The revenue procedure also covers late electing small business trusts (ESBTs), qualified subchapter S trusts (QSSTs) and qualified subchapter S subsidiaries (QSubs). However, this comment only focuses on the procedures for correcting an untimely S corporation election.
7
Rev. Proc. 2003-43, §4.03(1).
8
Rev. Roc. 2003-43, §4.03(2).
9
Rev. Proc. 2003-43, §4.02(4)(a) and (b).
10
As of the date of this comment there have been more than 100 information letters in which the IRS has granted relief under Rev. Proc. 2003-43. In addition the IRS has released more than 2000 private letter rulings addressing reasonable cause under §1362(b)(5).
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