CSG Law Alert: IRS Offers Simplified Process to Correct S-Corporation Missteps
On October 11, 2022, the Internal Revenue Service (the “IRS”) released Revenue Procedure 2022-19 (the “Procedure”). The Procedure provides relief for certain S corporation and QSub eligibility issues without having to obtain a private letter ruling (“PLR”). The IRS created these procedures to “(1) reduce burdens on taxpayers and the IRS, (2) facilitate increased taxpayer compliance with S election and QSub election rules, and (3) reduce costs and delays for completing transactions involving S corporations and QSubs.” The Procedure provides focused relief in six subject areas, as outlined below.
1. One class of stock requirement and governing provisions, including “principal purpose” conditions
One of the requirements for S corporation eligibility is that the corporation must have only one class of stock, a requirement that is generally satisfied if the S corporation’s governing provisions provide for identical distribution and liquidation rights among its stockholders. An S corporation’s governing provisions are defined in the regulations as “the corporate charter, articles of incorporation, bylaws, applicable State law, and binding agreements relating to distribution and liquidation proceeds.” In addition to its governing provisions, the S corporation and its shareholders may enter into other side agreements or arrangements (e.g., buy-sell agreements) that relate to distribution and liquidation proceeds and which may be interpreted as creating a second class of stock. The Procedure provides that such agreements do not violate the one class of stock requirement “so long as there was no principal purpose to use the agreement or arrangement as a means to circumvent the one class of stock requirement.” Importantly, the IRS will not issue PLRs to determine whether a “principal purpose” to circumvent the one class of stock requirement exists, due to the fact-intensive nature of this inquiry.
2. Disproportionate distributions
The Procedure further instructs that a disproportionate distribution will not violate the one class of stock requirement if the corporation’s governing provisions provide for identical distribution and liquidation rights. Read together with the instructions set forth in section 1, an S corporation election remains valid even after a disproportionate distribution provided that (1) the corporation’s governing provisions provide for identical distribution and liquidation rights; and (2) the shareholders have not entered into a side agreement with a principal purpose of using that agreement to circumvent the one class of stock requirement.
3. Certain inadvertent errors or omissions on Form 2553 or Form 8869
The Procedure clarifies that inadvertent errors or omissions on Forms 2553 or 8869 will not invalidate an S election unless with respect to (1) shareholder consents, (2) selection of a permitted year, or (3) an officer’s signature. If a Form fails to include a shareholder consent, then the corporation must seek relief under (a) section 1.1362-6(b)(3)(iii) of the regulations (extension of time), (b) Rev. Proc. 2013-30 (streamlined approach to requesting late election relief), or (c) Rev. Proc. 2004-35 (automatic relief for taxpayers in community property states). If none of these remedies apply, then the corporation may request PLR relief.
If the corporation fails to select a permitted year on Form 2553 or fails to include a required officer signature on Form 2553 or 8869, then the corporation must seek relief under Rev. Proc. 2013-30 (streamlined approach to requesting late election relief). If the corporation cannot obtain relief under Rev. Proc. 2013-30, then the corporation may request a PLR.
All other inadvertent errors or omissions on Forms 2553 and 8869 do not invalidate the S or QSub election. In these instances, the corporation can submit a correction request along with a written explanation to the IRS service center where it files its Form 1120-S.
4. Missing administrative acceptance letter for S election or QSub election
If a corporation did not receive or is missing an administrative acceptance letter for its S or QSub election, it can request a replacement letter by calling the IRS Business and Specialty Tax Line at 800-829-4933. Alternatively, practitioners may call the IRS Practitioner Priority Service Line. In either case, a missing letter will not invalidate the corporation’s S or QSub election and the IRS will not issue a PLR on this issue.
5. A Federal income tax return filing inconsistent with an S election or a QSub election
An S or QSub election is not invalidated if a corporation files a tax return that is inconsistent with its S or QSub election. Rather, the corporation may correct this mistake by filing corrected original or amended returns for the applicable tax years. The IRS will not grant PLR relief on this issue.
6. Non-identical governing provisions
By default, an S election is invalidated if a corporation has one or more governing provisions that allow for disproportionate distributions (non-identical governing provisions). The Procedure provides retroactive relief in these situations if the following conditions are satisfied:
1. The corporation has not made (and is not deemed to have made) a disproportionate distribution to a current or former shareholder during the period;
2. The corporation has timely filed Form 1120-S for each tax year beginning with the year the non-identical governing provision was adopted and continuing through the tax year immediately preceding the year that relief is requested; and
3. The above conditions are satisfied before the non-identical governing provision is discovered by the IRS.
For the second requirement, a Form 1120-S is considered timely filed if filed within six months of the original due date, excluding extensions. If the above criteria are met, then the corporation must submit corrective relief statements to the IRS by following the instructions provided in the Procedure. If the corporation cannot obtain relief under the Procedure, then the corporation may request a PLR which must include an explanation as to why the corporation could not satisfy the Procedure’s corrective relief requirements.
For more information, please contact your CSG Law attorney or the authors of this article.