Federal law generally recognizes two types of corporations for tax purposes: C Corporations and S Corporations. Certain entities can elect to be taxed as an S Corporation.[1] The distinction between C and S corporations is a federal tax concept–state law otherwise generally governs the other aspects of corporations as legal entities.
An S Corporation election requires the consent of all shareholders (or members, if an LLC is electing S-corporation status). Depending on when the election is made, the IRS will tax the corporation as a S Corporation either (1) beginning in the following tax year, or (2) beginning in the year that the election is made, if an election is made before the fifteenth day of the third month of the taxable year.[2] Generally, failure to file for S election before the fifteenth day of the third month bars the corporation from being treated as an S corporation during that year.[3] The Internal Revenue Code (IRC), however, provides exceptions to this rule when the failure to make a timely election was due to reasonable cause.[4] If this exception applies, the election becomes effective in the tax year it was intended to go into effect.[5]
While the S election statute does not specify precisely what constitutes reasonable cause, the IRS has issued guidance as to what must be demonstrated in order to receive relief for a late or nonexistent S election. Under this streamlined relief, not only must the S corporation demonstrate reasonable cause for its late or nonexistent election, but it must also have acted during that tax year as if the election had gone into effect. Thus, the entity and its shareholders must have reported income from the intended date of election as if reporting for an S Corporation.[6]
This streamlined exception is not available for an unlimited period of time. Under the guidance, among other steps, the entity must file for a corrective election using Form 2553 within three years and 75 days of the intended effective date of election.[7] This period may be extended, however, for corporations that failed to make a timely S election but reported income as if S election had gone into effect as long as (1) six months have passed since the corporation filed its first tax return as an S Corporation, and (2) the IRS failed to notify the corporation or its shareholders of any problems regarding its S Corporation status during this six-month period. This exception does not apply to entities that are also making a corporate classification election (e.g., LLCs making a corporate election in addition to S election).[8] This narrow exception often will not apply, as the IRS will generally notify entities of a deficient filing once the entity’s first tax return is rejected during processing.[9].
Taxpayers seeking relief from failing to make a S corporation election should seek legal advice from a tax attorney.
[1] See I.R.C. § 1362.
[2] I.R.C. § 1361(b)(1).
[3] See id. at § 1361(b)(3).
[4] Id. at § 1362(b)(5)(B).
[5] See id. at § 1362(b)(5); see Rev. Proc. 2013-30, 3 (I.R.S. Aug. 2013) [hereinafter “Revenue Procedure”].
[6] See Revenue Procedure at 20.
[7] See id. at 17-19.
[8] Id. at 21-22.
[9] Late Election Relief, Exception to the 3 Years and 75 Days Rule.
Need assistance in managing the business planning processes? Freeman Law advises clients with corporate and other entity formations and reorganizations. Restructuring entities—through conversions, mergers, and liquidations—can involve particularly complex tax and regulatory considerations. Freeman Law provides experienced tax and business counsel, helping our clients achieve their organizational goals in a tax-efficient manner. Schedule a consultation or call (214) 984-3000 to discuss your corporate structuring or business and tax planning concerns.
