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) 126.96.36.199.9 (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.
Share Your Thoughts!
If you are a paid subscriber, use the comments section below to discuss and ask questions about withdrawing an entity election.
Upcoming Education Events
Compass Tax Educators - Virtual
Sales are open for our 2022 webinar season all-access pass! Get over 30 CE/CPE at a bundled rate. Click here for additional information and to purchase.
Individual registration for each of the following webinars I am teaching will be open in a few months:
S Corps - Formation and Return Preparation - May 5, 2022
S Corps - Basis, Disposition, and Planning - May 19, 2022
Roth IRA Fundamentals - June 2, 2022
Tax Credits - August 4, 2022
Filing Status: Rules and Planning - August 18, 2022
Reasonable Compensation Issues & Planning - October 20, 2022
Representation Panel Discussion - November 3, 2022
2022 Individual Tax Update - December 8, 2022
2022 Business Tax Update - December 15, 2022
NATP - Florida Chapter - May 15-17, 2022 - Daytona Beach, FL - Live
Mastering Tax Research & Creating a Winning Tax Argument (3 CE); Disclosing Tax Return Positions (1 CE); Form 1099 Reporting, Compliance, and Reconciliation (2 CE); Circular 230 Ethics: Pricing Tax Engagements (2 CE); Entity Classification: Rules and Elections (2 CE); Tax Implications of Major Life Events (2 CE); Cryptocurrency Taxation (2 CE); Penalty Abatement Strategies (2 CE)
Oregon Society of Tax Consultants - May 20, 2022 - Newport, OR - Live
7 CE - To be announced
AICTP Tax Planning Academy - May 23-25, 2022 - San Diego, CA - Live
Virginia Society of Enrolled Agents - June 8-10, 2022 - Fredericksburg, VA - Live
Tax Planning - Individuals (2 CE); Tax Planning - Businesses (2 CE); Gambling Tax Issues (2 CE)
Florida Society of Enrolled Agents - June 17, 2022 - Orlando, FL - Live
Tax Planning - Individuals (2 CE); Mastering the Tax Research Process (2 CE); Rental Property Taxation (2 CE)
If the client submitted Form 2553, is the process the same?
What is the best way of changing from a current S Corporation (that isn't an LLC) to a Partnership?