Common S-Corporation Issues: Definitive Solutions Not Requiring Private Letter Rulings
Peter Tirella | 02.17.23
On October 19, 2022, the Internal Revenue Service (IRS) published Revenue Procedure 2022 – 19 (the “Revenue Procedure”), which provides six specific Taxpayer Assistance Procedures to help S‑Corporations (S‑Corp’s) and their shareholders definitively resolve common issues without obtaining a private letter ruling (PLR).
This article summarizes the Revenue Procedure and Taxpayer Assistance Procedures and further serves as a guideline for how an S‑Corp can resolve certain common issues without resorting to a time and cost-intensive PLR. This article does not replace reading the Revenue Procedure in its entirety, serve as legal advice, or establish an attorney-client relationship.
S‑Corp’s are borne of statute, specifically Sections 1361 and 1362 of the Internal Revenue Code (IRC). Specific prerequisites to make an S‑Corp election are outside the scope of this Article, but certain requirements will be discussed as they relate to the Revenue Procedure.
To reduce both costs and lengthy delays, the IRS issued the Revenue Procedure to address common issues typically not affecting an S‑Corp’s validity or election to be treated as such. The Taxpayer Assistance Procedures are discussed in turn below.
Taxpayer Assistance Procedures
1. Agreements and Arrangements with No Principal Purpose to Circumvent the “One Class of Stock Requirement”
S‑Corp’s may only have one economic class of stock, and that one class of stock must grant stockholders identical rights to distribution and liquidation proceeds (the “One Class of Stock Requirement”). Compliance with the One Class of Stock Requirement depends on the S‑Corp’s charter, articles of incorporation, bylaws, state law, and other binding agreements (collectively, “Governing Provisions”). In addition to Governing Provisions, rights granted by certain additional agreements between an S‑Corp and its shareholders could potentially create an impermissible second class of stock if the principal purpose of the agreement was to circumvent the One Class of Stock Requirement.
That isn’t to say that every additional agreement will run afoul of the One Class of Stock Requirement. So long as the agreement was not specifically intended to circumvent the One Class of Stock Requirement, the IRS will not view these agreements as a violation; entering into a permitted agreement will not terminate S‑Corp status.
It is important to note that whether the principal purpose of an agreement was to circumvent the One Class of Stock requirement is a question of fact, not law, so the IRS will not opine on such matters via PLR or otherwise.
2. Governing Provisions that Provide for Identical Distribution and Liquidation Rights
Under federal law, a “disproportionate distribution” is a corporation’s distribution of property with respect to certain shares of its stock that differs in timing or amount from distributions with respect to any other shares of its stock. Numerous taxpayers expressed concern that by providing their shareholders with certain disproportionate distributions, they may have unintentionally created an improper second class of stock.
Due to the volume of requests, the IRS explicitly stated in the Revenue Procedure that disproportionate distributions do not violate the One Class of Stock Requirement so long as the S‑Corp’s Governing Provisions provide for identical distribution and liquidation rights. For example, consider an S‑Corp that has Governing Provisions providing all stockholders with identical rights to distributions and liquidation proceeds. If for some proper reason the S‑Corp gave Shareholder #1 a $50,000 distribution in 2021 and Shareholder #2 a $50,000 distribution in 2022, the two distributions would be disproportionate because they were given at different times. Assuming that there was no intent to create a second class of stock by staggering the distributions, because the Governing Provisions did not provide a right to the disproportionate distributions, the IRS would not treat the S‑Corp as having created more than one class of stock. Therefore, the two staggered distributions would not affect the S‑Corp’s S‑Election.
Because the types of disproportionate distributions discussed above will not affect an S‑Corp’s continued existence, taxpayers do not need to seek, and the IRS will refuse to provide, official relief in connection with such distributions.
3. Procedures for Addressing Missing Shareholder Consents, Errors Regarding a Permitted Year, Missing Officer’s Signature, and Other Inadvertent Errors and Omissions
The following are common issues faced by S‑Corp’s which can easily be solved by complying with the following Revenue Procedure guidelines:
Missing Shareholder Consents
If an S‑Corp fails to include a shareholder’s consent in connection with its S‑Election, the S‑Corp may:
- Request a time extension to file a shareholder consent, under 26 CFR § 1.1362 – 6(b)(3)(iii);
- Comply with Revenue Procedure 2013 – 30, which provides a simplified method for taxpayers to obtain relief for late S‑Elections;
- Comply with Revenue Procedure 2004 – 35, which provides certain taxpayers with automatic relief for late shareholder consents in community property states; or, if none of the above are applicable; or
- Request a PLR from the Associate Chief Counsel under 26 U.S.C. § 1362(f) if none of the above solutions are applicable.
Correcting an Error Regarding a Permitted Year
If an S‑Corp inadvertently submits a Form 2553 (which is necessary for an S‑Election) with an error regarding a permitted year, the S‑Corp may remedy the error by complying with Revenue Procedure 2013 – 30, linked above. If this Revenue Procedure is not applicable, the S‑Corp can instead submit a request for a PLR under 26 U.S.C. 1362(f).
Missing Officer’s Signature
If a Form 2553 is missing the signature of an S‑Corp’s officer, and the absence of such signature would affect the S‑Corp’s status as such, the S‑Corp may remedy the error by complying with Revenue Procedure 2013 – 30, linked above. If this Revenue Procedure is not applicable, the S‑Corp can instead submit a request for a PLR under 26 U.S.C. 1362(f).
Other Inadvertent Errors or Omissions
Any errors in a Form 2553 not discussed above may be remedied by submitting a written explanation of the error to the appropriate Internal Revenue Submission Processing Center.
Importantly, the IRS will not issue a PLR under 26 U.S.C. 1362(f) for any inadvertent error or omission described above because these inadvertent errors or omissions do not affect the S‑Corp’s S‑Election. Further, the IRS will not issue a PLR for missing required consents, errors regarding a permitted year, or a missing officer’s signature unless the taxpayer has no other viable means of requesting relief.
4. Procedures for Verifying S Elections
If an S‑Corp or its representatives find the administrative acceptance letter for an S‑Election missing or otherwise unavailable, (i) an S‑Corp or one of its shareholders may contact the IRS Business and Specialty Tax Line at (866) 860 – 4933; or (ii) a practitioner may contact the IRS Practitioner Priority Service at (866) 860 – 4259.
Because a missing administrative acceptance letter does not affect an S‑Election, the IRS will not issue a PLR in these instances.
5. Procedures for Addressing a Federal Income Tax Return Filing Inconsistent with an S Election or Qsub Election
If an S‑Corp mistakenly filed a Federal income tax return inconsistent with its status as an S‑Corp, the S‑Corp must file a Federal tax return for open taxable years that is consistent with its status as an S‑Corp.
An erroneous tax filing does not impact the validity of an S‑Election, so the IRS will not issue a PLR in connection with such filings.
Importantly, because erroneous tax filings do not impact an S‑Corp’s status as such, the S‑Corp’s distributions and other transactions will be treated consistent with its status as an S‑Corp. The same applies for Qsubs which make erroneous filings; in such cases, the Qsub’s income or deductions would still be treated as income or deductions of the parent S‑Corp and distributions between the Qsub and its parent S‑Corp would still be disregarded.
Qsubs are corporations eligible to make an S‑Election and that are 100% owned by an S‑Corp that itself files a Qsub election for its subsidiary.
6. Procedures for Retroactively Correcting One or More Non-Identical Governing Provisions
As previously noted, an S‑Corp can immediately lose its S‑Corp status if its Governing Provisions violate the One Class of Stock Requirement. These improper provisions are known as “Non-Identical Provisions.” While the termination will be automatic, an S‑Corp can remedy the termination and be retroactively treated as an S‑Corp if it meets certain requirements. To qualify for such relief, the S‑Corp and its shareholders must have:
- One or more Non-Identical Provisions;
- Not made, and have not been deemed by the IRS to have made, a disproportionate distribution;
- Timely filed a Form 1120‑S return for each year beginning on the year the S‑Corp adopted the first Non-Identical Provision and through the year which the S‑Corp made a request for corrective relief; and
- Followed all Revenue Procedure requirements before the IRS discovers any Non-Identical Provision.
Practitioners and shareholders should be keenly aware that once the IRS discovers the Non-Identical Provision, the former S‑Corp is barred from relief under this Revenue Procedure; therefore, a swift response is critical.
To request relief, the S‑Corp must complete a Corporate Governing Provision Statement, and all stockholders who owned stock while the improper provision was in effect must file a Shareholder Statement. Practitioners should carefully review the informational requirements for each statement, but generally each requires various representations and factual statements about the relevant Non-Identical Provision and responsive action following discovery.
If an S‑Corp is not qualified to obtain relief for a Non-Identical Provision, it may still proceed to request a PLR from the Associate Chief Counsel (Passthroughs and Special Industries). However, the S‑Corp must include a statement explaining each reason why the requirements for relief under the Revenue Procedure could not be satisfied.
By publishing this Revenue Procedure, the IRS made clear that there are certain issues for which they will categorically refuse to issue PLRs. There are other circumstances where they will generally not issue PLRs. As a quick synopsis, these two categories are summarized below:
IRS Categorically Refuses to Issue PLRs
- Whether the principal purpose of an agreement or transaction was to circumvent the One Class of Stock Requirement
- Whether the principal purpose of an agreement or transaction was to circumvent distribution rights or the limitation on eligible S‑Corp shareholders
- Whether the principal purpose of an unwritten advance was to circumvent the rights of outstanding shares or the limitation on eligible S‑Corp shareholders
- Determinations related to disproportionate distributions, if there are no Non-Identical Provisions
- Missing S‑Election acceptance letters
- Tax filings inconsistent with the S‑Corp’s status as such
IRS Generally Refuses to Issue PLRs
- Situations where the IRS has provided automatic approval or administrative procedures for an S‑Corp to obtain relief for late S‑Corp elections or retroactive corrective relief regarding Non-Identical Provisions
- Whether an inadvertent error, omission, or missing required consent or signature on Form 2553 affects an S‑Corp’s S‑Election
These items only supplement the categories for which the IRS will refuse or generally disfavor issuing PLRs. This Article does not provide a full analysis of all tax rules and regulations, so it is necessary to independently read and understand all applicable PLRs and related IRS guidance.
If you currently own an S‑Corp or are considering making an S‑Election in the near future, please reach out to your usual Boardman Clark attorney or another member of our Business Practice Group to discuss the applicability of this Revenue Procedure to your specific circumstances.
DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.