Avoiding inadvertent termination of an S election.

• Date: 01 August 2022
• Author: Hunley, Shaun M.

If an S corporation fails to maintain its status as a "small business corporation" under Sec. 1361(b), its S election automatically terminates on the date the disqualifying event occurs. The disqualifying events that can terminate S status include the following (Secs. 1362(d)(2) and 1361(b)(1); Regs. Sec. 1.1362-2(b) (1)):

* Having more than 100 shareholders. The S corporation can have more than 100 shareholders in total during the year as long as there are no more than 100 shareholders at any given time.

* Having an ineligible shareholder (e.g., a corporation, partnership, ineligible trust, or nonresident alien). Partnership and corporate shareholders generally are not permitted, other than so-called transitory ownership as part of a corporate reorganization.

* Having more than one class of stock. Differences in voting rights are allowed, which can be useful, for example, when transferring nonvoting common stock to younger family members or trusted employees.

* Becoming an ineligible corporation such as an insurance company or a domestic international sales corporation.

* Transferring place of incorporation to a foreign country (thus no longer qualifying as a domestic corporation).

The IRS issued technical advice stating that a corporation's S election was not terminated by using an impermissible tax year (Technical Advice Memorandum 9505003). Sec. 1362 provides the specific events that can cause a corporation to fail to meet...