Tom Talks Taxes - February 4, 2022
How to undo an unwanted S corporation election for a LLC
Clients sometimes hear “you should be a S corporation” and make the S corporation election for their LLC without asking you, their trusted tax advisor.
Alternatively, perhaps you recommended a S corporation election, but the situation has substantially changed, and it no longer is optimal.
One option is to rescind the S corporation election and then revoke the underlying corporation election. For two reasons, this option is sub-optimal:
The revocation of the corporation election is a deemed taxable liquidation of the corporation. See Treas. Reg. §301.7701-3(g)(1)(ii), (iii).
The taxpayer will likely still have to file a S corporation return for one tax year.
If the taxpayer has not filed the LLC’s first S corporation return, then there is a time sensitive opportunity to undo the election as if it never occurred by withdrawing the underlying corporation election. This allows the LLC to remain either a disregarded entity (single-member LLC) or a partnership (multi-member LLC).
When a taxpayer withdraws a corporation election, he or she avoids all the tax consequences of revocation because the IRS treats the election as if the taxpayer never made it. Internal Revenue Manual (IRM) 18.104.22.168.9 (01-01-2022), Request to Withdraw Classification Election, states the following in regard to corporation election withdrawals:
The IRS must receive the withdrawal request prior to the unextended due date of the first corporation tax return.
The IRS permits the withdrawal via another Form 8832, Entity Classification Election, or written correspondence.
If the taxpayer also has an S election in place, then the withdrawal of the corporation election also terminates the S election.
Here’s an example: Joan, a new client to you, engages you for 2021 tax preparation. Joan formed a new single-member LLC in 2021 and made a timely S corporation election effective January 1, 2021; however, her net income in the business is only $35,000, and she doesn’t anticipate it growing significantly over the next few years. Joan also never paid herself wages from the LLC (shocking!). If you determine Joan is better from a tax perspective to report the business on Schedule C, then you can withdraw the corporation election (and terminate the S election simultaneously) by filing a withdrawal statement or Form 8832 with the IRS before March 15, 2022.
As a best practice to ensure proper and timely IRS processing, make sure the IRS receives a clearly written statement citing the relevant IRM provision well in advance of the deadline. In the current IRS environment of significant mail and processing delays, retaining proof of timely IRS receipt of the request is essential.
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