Eligibility, elections and terminations. .

• Author: Karlinsky, Stewart S.
• Position: S Corporations - Part 2

Part I of this article, in the October 2002 issue, addressed S corporation operational issues, including accounting methods, loss limits and corporate reorganizations. Part II, below, discusses S eligibility, elections and termination issues. During the period covered, final regulations and several revenue procedures were issued on S accounting periods and electing small business trusts (ESBTs). Numerous letter rulings on corporate and shareholder eligibility were issued as well.

Eligibility, Elections and Terminations

The general definition of an S corporation in Sec. 1361 includes restrictions on the types and number of shareholders, as well as the kinds of corporations, that qualify for the election. If an S corporation violates any of these restrictions, its S election automatically terminates. However, the entity can request an inadvertent-termination ruling under Sec. 1362(f) and, subject to IRS approval, retain S status continuously.

Elections

Filing an S Election

To qualify as an S corporation, the corporation and all its shareholders on the date of the election (as well as other affected shareholders) must timely file a valid Form 2553, Election by a Small Business Corporation (under section 1362 of the Internal Revenue Code). This election should be sent by certified mail (return receipt requested), registered mail or a pre-approved private delivery service (e.g., Federal Express, Airborne Express, DHL or UPS). However, in Letter Ruling 200211023, (22) the IRS granted S status from the date of incorporation, even though it had no record of receiving Form 2553 and there was no proof the taxpayer mailed it.

Late Elections

Rev. Proc. 98-55 (23) grants S corporations a 12-month automatic extension to file Form 2553 without obtaining a letter ruling, thus avoiding the user fee. Nonetheless, the IRS continues to receive numerous letter ruling requests (24) on late filing of Form 2553. In all instances, the IRS allowed S status from inception under Sec. 1362(b)(5), as long as the taxpayer fried a valid Form 2553 within 60 days of the ruling. In some cases, (25) Form SS-4, Application for Employer Identification Number, and Form 1120S, U.S. Income Tax Return for an S Corporation, had been fried indicating the corporation was an S corporation; however, Form 2553 was not filed prior to the ruling request.

In other rulings, (26) a general manager, lawyer, accountant, tax preparer or financial consultant forgot to complete or mail Form 2553, but the company filed an S return and the shareholders included the income on their individual returns. The IRS allowed S status from the company's inception in all cases.

Who Should Sign Form 2553?

A question sometimes arises as to who must sign Form 2553. Per Sec. 1362(a)(2), all shareholders who own stock on the date of the election must sign it. If the election is to be retroactive to the beginning of the year, Sec. 1362(b)(2)(B) requires all who owned stock that year (before the election) to also sign. In Letter Ruling 200205024, (27) an S corporation filed Form 2553 with certain shareholders' signatures missing. In addition, nonvoting shares of stock were inadvertently issued to a partnership (an ineligible shareholder); when this matter was discovered, the shares were reissued to the individual partners and the corporation's return was amended. The Service determined the S election was inadvertently invalid (for failure to attach certain shareholder consents) and inadvertently terminated (by the stock issuance to the partnership), but allowed the corporation to retain S status.

Another issue is who must sign Form 2553 when a trust is a shareholder. The trust beneficiary or his or her legal representative should sign the form, not the trustee (except for an ESBT, for which the trustee signs the form). In Letter Ruling 200144023, (28) a trustee of family trusts signed Form 2553 as the trustee, not as a deemed owner. The Service determined the improper execution of the shareholder consents was inadvertent.

In Letter Ruling 200148031, (29) a C corporation's shareholders were four individuals and seven ESBTs. At the same time the corporation made an S election, seven more ESBTs (for the same beneficiaries) were established as shareholders. When Form 2553 was filed, the trustee for the 14 trusts signed the consent statement seven (not 14) times, as owner of the...