Tom Talks Taxes - February 24, 2023

When can an entity make a late S corporation election?

Many tax professionals need clarification concerning when a taxpayer qualifies to make a late S corporation election. Late elections are permitted outside the private letter ruling process in specific circumstances. This article will review how to make a timely S corporation election and when the IRS will approve late S corporation elections under its simplified procedure.

For a corporation to be treated as an S corporation for federal tax purposes, it must file an election within the required timeframe for the first tax year for which the S corporation election is to take effect. A taxpayer makes the election on Form 2553, Election by a Small Business Corporation. §1362(b)(2) states the S corporation election for a tax year must be filed

• At any time during the preceding tax year, or

• On or before the 15th day of the 3rd month of the tax year.

Example 1. Pink, Inc., wants to elect S corporation treatment effective January 1, 2023. It must file Form 2553 no earlier than January 1, 2022, and no later than March 15, 2023, for a timely election.

Example 2. Yellow, Inc., a fiscal year corporation with a June 30 year-end, wanted to elect S corporation treatment effective July 1, 2022. It must file Form 2553 no earlier than July 1, 2021, and no later than August 15, 2022, for a timely election.

If the entity is a limited liability company (LLC), either single-member or multi-member, it must elect to be treated as an association taxed as a corporation before the S election. Treas. Reg. §301.7701-3(c)(1)(iii) states the corporation election for a tax year must be filed

• At any time during the preceding 12 months, or

• On or before the 75th day of the tax year.

A taxpayer can make the corporation classification and S corporation elections by filing Form 2553; no Form 8832, Entity Classification Election, is required. This is explicitly stated in Treas. Reg. §301.7701-3(c)(1)(v)(C) and confirmed in the “Purpose of Form” section of the Form 2553 instructions.

Example 3. Green, LLC, a single-member disregarded entity, wanted to elect S corporation treatment effective January 1, 2022. It must file Form 2553 no earlier than January 1, 2021, and no later than March 15, 2022, for a timely election.

Example 4. Purple, LLC, a calendar-year multi-member partnership, wants to elect S corporation treatment effective April 1, 2023. It must file Form 2553 no earlier than April 1, 2022, and no later than June 15, 2023, for a timely election. Purple, LLC will file two short-year returns: Form 1065 for January 1, 2023 through March 31, 2023, and Form 1120S for April 1, 2023 through December 31, 2023.

The IRS must grant late election relief if the S election is not filed within the above timeframes. Rev. Proc. 2013-30 provides a simplified method to receive that relief; a taxpayer that does not qualify under Rev. Proc. 2013-30 must receive relief via a private letter ruling. A taxpayer must include “FILED PURSUANT TO REV. PROC. 2013-30” on the top of Form 2553 when requesting late S election relief under the revenue procedure.

Sec. 4.02 of Rev. Proc. 2013-30 states the four basic requirements to qualify for a late S corporation election:

1. The taxpayer intended to be classified as an S corporation as of the effective date,

2. The taxpayer requests relief under this revenue procedure within 3 years and 75 days after the effective date,

3. The failure to qualify as an S corporation was solely because the election under subchapter S was not timely filed by the due date of the election under subchapter S, and

4. The requesting entity has reasonable cause for its failure to make the timely election under subchapter S and has acted diligently to correct the mistake upon its discovery.

Sec. 5.03 has additional requirements that must be addressed for a late corporate classification election intended to be effective on the same date as the late S corporation election:

1. The taxpayer is an eligible entity as defined in § 301.7701-3(a),

2. The taxpayer intended to be classified as a corporation as of the effective date of the S corporation status,

3. The taxpayer fails to qualify as a corporation solely because Form 8832 was not timely filed under § 301.7701-3(c)(1)(i), or Form 8832 was not deemed to have been filed under § 301.7701-3(c)(1)(v)(C),

4. The taxpayer fails to qualify as an S corporation on the effective date of the S corporation status solely because the S corporation election was not timely filed pursuant to § 1362(b), and

5. Either:

   1. The taxpayer timely filed all required federal tax returns and information returns consistent with its requested classification as an S corporation for all of the years the entity intended to be an S corporation and no inconsistent tax or information returns have been filed by or with respect to the entity during any of the taxable years, or

   2. The taxpayer has not filed a federal tax or information return for the first year in which the election was intended to be effective because the due date has not passed for that year’s federal tax or information return.

A taxpayer can request relief beyond the standard 3-year 75-day period if it meets the requirements under Sec. 5.04 of Rev. Proc. 2013-30. If a taxpayer does not qualify for late election relief under Rev. Proc. 2013-30, the taxpayer can request relief via private letter ruling if the taxpayer meets the requirements in Treas. Reg. §301.9100-3.

The narrative explaining the late election relief should address each of the four elements for late S corporation elections listed above. If the taxpayer is an LLC, it should also address the elements for a late corporate classification election.

Example 5. Reese has had Red LLC, a disregarded entity, since 2019. He has always reported the business activity on Schedule C on timely filed returns. On February 15, 2022, he filed his 2021 Form 1040 with Schedule C. In May 2022, he called his tax professional to ask a question, and at that time told the tax professional that he put himself on payroll effective January 1, 2022 because he wanted Red, LLC to be treated as an S corporation for tax year 2022. Reese was unaware an election had to be filed prior to the S corporation tax return filing. His tax professional promptly filed Form 2553 to request late S corporation election relief effective January 1, 2022.

Red, LLC qualifies for late corporation classification and S corporation election relief because Red, LLC meets all of the above criteria, including the intent to be an S corporation effective January 1, 2022, which is demonstrated through starting wage payments to the owner.

Here is a sample late election relief narrative that can be included with Form 2553:

The taxpayer was unaware that a separate election was required to treat a single-member LLC as an association taxable as a corporation and as an S corporation for federal tax purposes. The taxpayer intended to be treated as a S corporation effective January 1, 2022. The taxpayer began paying its owner a salary as an employee in January 2022, which would not be permitted if it continued to be a disregarded entity. Once the taxpayer discovered the oversight in May 2022, the taxpayer's accountant immediately prepared Form 2553 to request late election relief under Rev. Proc. 2013-30 for both elections.

Example 6. Sarah has had Teal, LLC, a disregarded entity, since 2017. She has always reported the business activity on Schedule C on timely filed returns. On February 15, 2023, she filed her 2022 Form 1040 with Schedule C. In May 2023, she meets with a new tax planning advisor who, after doing an entity analysis, determines she would have had significant tax savings with an S corporation in prior tax years.

Teal, LLC does not qualify for late S election relief for tax years 2022 and prior because Sarah filed federal tax returns consistent with the disregarded entity status. Teal, LLC does not qualify for late S election relief effective January 1, 2023 because Sarah did not intend to be treated as an S corporation on that date, which is evidenced by the failure to establish payroll for Sarah as an S corporation employee.

In conclusion, a late S corporation election is not a fix for failure to do proactive tax planning; it is only meant to cure S corporation election errors due to failure to file Form 2553. A taxpayer who identifies that S corporation treatment can immediately save federal tax can begin realizing those savings by doing a prospective election to create a short-year S corporation in the current year.

For example, in Example 6, Teal, LLC can make a timely S corporation election effective June 1, 2023 in order to begin receiving S corporation tax benefits during the 2023 tax year.

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