Obtaining a waiver of an invalid S election. (2024)

The IRS has authority to waive the effect of an invalid election.When an S corporation election is ineffective because the corporationfailed to qualify as a small business corporation, or obtain shareholderconsents, the corporation will be treated as an S corporation during theperiod specified by the IRS if all of the following conditions are met(Sec. 1362(f)):

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1. The IRS determines that the circ*mstances resulting in theineffective election were inadvertent.

2. "Within a reasonable period after discovering thecirc*mstances causing the invalidity, steps are taken to qualify thecorporation as a small business corporation or to obtain the requisiteshareholder consents (including elections for QSSTs and ESBTs).

3. During the period that the S election was ineffective, thecorporation and each shareholder agree to adjustments required by theIRS pertaining to that period.

The IRS has provided the following ways to obtain relief frominvalid elections:

1. Extension of time to obtain consents under Regs. Sec. 1.1362-6.If the S election is invalid because shareholder consents were omitted,Regs. Sec. I.l362-6(b)(3)(iii) provides that the S corporation canrequest an extension of time to furnish the consents. No user fee isrequired.

2. Relief from late election under Rev. Proc 2007-62. If theelection is late, relief is provided under Rev. Proc. 2007-62, whichallows the S corporation to file a late Form 2553, Election by a SmallBusiness Corporation, along with the corporation's first Scorporation income tax return. Under Rev. Proc. 2007-62, a corporationcan obtain relief from filing a late S election if a request for reliefis filed no later than six months after the original due date (excludingextensions) of the Form 1120S, U.S. Income Tax Return for an SCorporation, for the year the election was first intended. The Scorporation must show reasonable cause why the election was not filed ina timely manner. No user fee is required.

3. Relief from late election under Rev. Proc. 2003-43. If the Selection is late, relief is provided under Rev. Proc. 2003-43, whichallows the S corporation to file Form 2553 even though the due date haspassed. Under Rev. Proc. 2003-43, a corporation can obtain relief forfailing to file an S election if a request for relief is filed within 18(or, in certain cases, 24) months of the original due date of the Selection. The S corporation must show reasonable cause why the electionwas not filed in a timely manner. No user fee is required.

4. Relief from late election under Rev. Proc. 97-48. Late Selections are also permitted under Rev. Proc. 97-48. The corporationmust have filed S corporation tax returns (Form 1120S), and theshareholders must have reported their income consistent with S statusfor the tax year in which the S election should have been made and forall later years. No user fee is required.

5. Letter ruling. The S corporation can request relief from aninvalid election by obtaining a letter ruling (Announcement 97-4; seealso Rev. Proc. 2003-43). A user fee must accompany the request for aletter ruling.

The IRS has seemingly been generous in waiving invalid elections(as it has with granting relief from inadvertent terminations). Innumerous letter rulings, the IRS has ruled that the corporation hadreasonable cause for not filing its election on time and allowed the Selection to become effective on the date requested. For example, invalidelection relief was granted when the taxpayer relied on other parties tofile the Form 2553 (IRS Letter Rulings 9809033, 200239015, and200302025); when the corporation had an ineligible shareholder on thedate the election was to become effective (IRS Letter Rulings 9716015and 9717019); when employees inadvertently failed to mail the Form 2553(IRS Letter Rulings 9719009 and 9720019); and even when no reason wasgiven for the late filing (IRS Letter Rulings 200303039, 200303049, and201048027).

Relief Under Rev. Proc. 2007-62

Rev. Proc. 2007-62 allows eligible small business corporations torequest relief from a late S corporation election by filing Form 2553with the S corporation's first income tax return. The procedure isin lieu of the letter ruling process ordinarily used to obtain relieffor late elections. Accordingly, no user fee is required. Rev. Proc.2007-62 can be used to correct a late filed S election if the followingrequirements are met:

1. The corporation fails to qualify for its intended status as an Scorporation on the first day that status was desired solely because ofthe failure to timely file an S election with the appropriate IRSService Center.

2. The request for relief from the late election is filed no laterthan six months after the original due date (excluding extensions) ofthe Form 1120S for the year the election was first intended (i.e., itsfirst Form 1120S).

3. The corporation has not yet filed its first Form 1120S.

4. The corporation has reasonable cause for its failure to make atimely election.

5. All taxpayers whose tax liability or tax returns would beaffected by the election (including all shareholders of the Scorporation) have reported consistently with the S corporation electionon all affected returns for the year the election was intended and forany subsequent years. (This basically means that proper Schedules K-lhave been issued to the shareholders and they have reported thepassthrough items on their tax returns as if a valid S election was ineffect.)

Under Rev. Proc. 2007-62, the taxpayer attaches a completed Form2553 to its first Form 1120S. Page 1 of Form 2553 includes a space forentering an explanation giving reasonable cause for the late election.Forms 1120S and 2553 must be filed no later than six months after theoriginal due date (excluding extensions) of the S corporation'sfirst return.

When it is discovered that Form 2553 has not been timely filed, theplanner must decide which revenue procedure is the most efficient underthe circ*mstances. For example, Rev. Proc. 2007-62 provides that Form2553 is to be filed together with the corporation's first S return,Form 1120S. On the other hand, Rev. Proc. 2003-43 calls for the lateForm 2553 to be mailed or otherwise delivered to the appropriate IRSService Center. If the late S election is discovered several monthsbefore Form 1120S is due, it is advisable to use the Rev. Proc. 2003-43procedures to correct the error.

Although the chances of the IRS granting relief are very good,approval is not automatic. So, filing under Rev. Proc. 2003-43 beforethe tax return is filed in order to verify the S election'svalidity as soon as possible may be the best way to proceed. However, ifForm 1120S is to be filed soon, sending Forms 1120S and 2553 togetherunder Rev. Proc. 2007-62 may be the most efficient course to follow.

Relief Under Rev. Proc. 2003-43

Rev. Proc. 2003-43 relief for a late S election is available if thefollowing requirements are met:

1. The corporation fails to qualify for its intended status as an Scorporation on the first day that status was desired solely because ofthe failure to timely file an S election with the appropriate ServiceCenter.

2. Less than 24 months have passed since. the original due date ofthe S election.

3. The corporation has reasonable cause for its failure to make atimely election.

4. All taxpayers whose tax liability or tax returns would beaffected by the election (including all shareholders of the Scorporation) have reported consistently with the S corporation electionon all affected returns for the year the election was intended, and forany subsequent years. (This basically means that proper Schedules K-lhave been issued to the shareholders and they have reported thepassthrough items on their tax returns as if a valid S election was ineffect.)

The deadline for filing for late S election relief depends onwhether the corporation has filed a tax return (Form 1120S):

* If the corporation has not filed Form 1120S, the election Form2553 must be filed under Rev. Proc. 2003-43 by the earlier of 18 monthsafter the original due date for the S corporation election, or sixmonths after the due date of Form 1120S (excluding extensions) for thefirst year the election was intended.

* If the corporation has filed Form 1120S for the first year inwhich the election was intended, the application for relief is filedunder Rev. Proc. 2003-43 within 24 months of the original due date forthe S corporation election. To qualify for relief, Form 1120S must havebeen filed within six months of the due date of Form 1120S (excludingextensions).

All taxpayers whose tax liability or tax returns would be affectedby the election (including all shareholders of the S corporation) musthave reported consistently with the S corporation election on allaffected returns for the year the election was intended, and for anyfollowing years.

The application for relief under Rev. Proc. 2003-43 for a late Selection is made by filing a properly completed Form 2553 with theService Center where the original S election would have been filed.

Relief Under Rev. Proc. 97-48

Rev. Proc. 97-48 provides automatic relief for late S corporationelections. No user fee is required when relief is sought under thisprocedure. Rev. Proc. 97-48 applies if all of the following conditionsare met:

1. The corporation fails to qualify as an S corporation solelybecause Form 2553 was not timely filed.

2. The corporation and all of its shareholders reported theirincome consistent with S corporation status for the year the Scorporation election should have been made, and for every subsequent taxyear, if any.

3. At least six months have elapsed since the corporation filed itstax return for the first year the corporation intended to be an Scorporation.

4. Neither the corporation nor any of its shareholders has receivednotice from the IRS regarding its S corporation status within six monthsof when it timely filed Form 1120S for the first year.

Rev. Proc. 97-48 can preserve the S status of a corporation thatdid not timely file its S election, Form 2553. The procedure alsoapplies to an S corporation that thought it had validly filed itselection and has subsequently filed Form 1120S for several years. Theprocedure cannot be used, however, if the corporation received noticefrom the IRS regarding its S corporation status within six months ofwhen it filed its first Form 1120S.

Corporations that are ineligible for relief under Rev. Proc. 97-48can still ask for a letter ruling granting relief from the late Selection.

This case study has been adapted from PPC's Tax PlanningGuide-S Corporations, 25th Edition, by Andrew R. Biebl, Gregory B.McKeen, George M. Carefoot, and James A. Keller, published byPractitioners Publishing Company, Ft. Worth,TX, 2011 ((800) 323-8724;ppc.thomson.com).

Editor: Albert B. Ellentuck, Esq.

EditorNotes

Albert Ellentuck is of counsel with King & Nordlinger, LLP, inArlington, VA.