In order for a corporation to be taxed (or not taxed) as an S corporation, it must file an election on Form 2553 no more than two months and 15 days after the beginning of the first year that it wants to be treated as an S corporation. Many things can go wrong with filing the initial election and with maintaining the election, including failure to qualify as a small business corporation, failure to obtain consents of shareholders, and most importantly, just a garden variety failure to file the initial election on time.
A common scenario seems to be that the organizers of the corporation intend that it be an S corporation and somehow assume that they can take care of that when the time comes to file the first return. But, Congress thought otherwise, because it wanted the proper taxpayers to start making estimated tax payments way ahead of return filing time, hence the two month and 15 day due date for the election.
Despite the commonness of the election foot faults, and despite the Congress’ willingness to help taxpayers rectify the foot faults, the IRS’ efforts to help taxpayers can be roadblocks when the taxpayer does not happen to fit into one of the three tightly defined automatic late election procedures. In those cases, the taxpayer is left with the more expensive letter ruling route; the IRS fee for letter rulings now is $18,000.
The Statute. Section 1362(f) authorizes the Secretary to allow late S corporation elections to be retroactive if:
- the failure to elect was inadvertent;
- within a reasonable time after discovery, steps were taken to acquire shareholder consents to the election; and
- the corporation and shareholders agree to make the adjustments necessary to reflect S corporation treatment.
The Regulation. Reg. §1.1362-4 amplifies the statute as follows:
- Inadvertence is evidenced by proof that invalidity of the election was not reasonably within the control of the corporation.
- Even though the statute could be read to refer only to an election actually made, but which was somehow incomplete, the regulation equates an ineffective election with an election that was intended but not made (Reg. § 1.1362-4(c)).
- Subsection (f) allows the Secretary to make the election retroactive for the period during which the facts justifying the relief existed. This is why letter rulings allowing late elections are not 9100 relief: they are not for a late regulatory election, but for a late statutory election, for which the statute itself allows relief.
The Three Automatic Procedures. The IRS evidently believes that taxpayers usually discover a late election either (a) when the IRS tells them they did not file an election after filing a tax return as an S corporation, or (b) when the corporation comes to file the first return and realizes it failed to make the election earlier. Therefore, the automatic relief procedures described below are keyed to those circumstances.
Although the regulation allows relief by private letter ruling, which the IRS regularly grants, the IRS has created three separate revenue procedures to grant automatic relief in defined cases through the filing of a late election Form 2553. No $18,000 fee is required. In all cases, the time for filing the Form 2553 election has passed. The common scenarios are as follows:
- Form 1120S timely filed for the first year for which election intended:
A. Within six months, the IRS notifies the corporation of its failure to elect:
1.within 24 months of the original election due date, the corporation can obtain automatic relief
under Rev. Proc. 2003-43; and
2.beyond 24 months of the original election due date the corporation can seek relief by a letter ruling.
B. Within six months, the IRS does not notify the corporation of its failure to elect:
1. the corporation and its shareholders have consistently reported as an S corporation: the
taxpayer can obtain automatic relief under Rev. Proc. 97-48; and
2. the corporation and its shareholders have not consistently reported as an S corporation: the
taxpayer can seek relief by a letter ruling.
- Form 1120S filed during the six months after the due date:
A. Within 24 months of original election due date, the taxpayer can obtain automatic relief under Rev. Proc. 2003-43.
B. Beyond 24 months of the original election due date, the taxpayer can seek relief by a letter ruling.
- Form 1120S not filed within six months after the due date:
A. Within six months after the due date, file Form 2553 under Rev. Proc. 2003-43.
B. Within six months after the due date, file Form 2553, plus Form 1120S, under Rev. Proc. 2007-62.
C. If neither action is taken within six months, seek letter ruling.
If automatic relief is available, it must be sought. Rev. Proc. 2012-3. If not, a letter ruling is available, unless the statute of limitations has run on a year that needs to be adjusted to properly reflect the S corporation items. See LTR 200333017.
Suggestion. Neither the IRS, nor the commentators have spelled out the options in menu format, as attempted above. Rather, the automatic extension procedures have sort of grown up episodically. The IRS would do well to rethink the entire area and come up with one procedure that encompasses all routes to relief.
Written by Jack Cummings, Partner, Tax, (919)-862-2302 | Alston & Bird LLP