IRS provides guidance on perfecting S elections and QSub elections.

AuthorAlberty, Jeff

The IRS released Rev. Proc. 2022-19, which expands Rev. Proc. 2013-30 (providing a simplified method for taxpayers to request relief for late elections by S corporations, qualified Subchapter S subsidiaries (QSubs), electing small business trusts (ESBTs), and qualified Subchapter S trusts (QSSTs)). Rev. Proc. 2022-19 also amplifies Rev. Proc. 2004-35 (providing automatic relief for certain taxpayers requesting relief for late shareholder consents for S elections in community property states). In addition, Rev. Proc. 2022-19 adds certain no-rule areas with respect to IRS letter ruling requests, consistent with the guidance provided in the revenue procedure.

The guidance focuses on six issues:

(1) nonidentical governing provisions;

(2) principal-purpose determinations regarding the one-class-of-stock requirement; (3) disproportionate distributions; (4) certain inadvertent errors or omissions on Form 2553, Election by a Small Business Corporation, or Form 8869, Qualified Subchapter S Subsidiary Election; (5) missing administrative or acceptance letters for an S or QSub election; and (6) the requirement to file returns consistent with an S election.

Self-help relief available for certain nonidentical governing provisions

The governing provisions of an S corporation cannot provide for disproportionate distribution or liquidation rights (i.e., nonidentical governing provisions) among any shares of stock, or else the S corporation will have two classes of stock and will be ineligible to have an S election (Regs. Sec. 1.1361-1(1)). This most often applies in the context of a limited liability company with an

S election that has governing provisions more common to those of a partnership, such as distribution or liquidation rights based upon capital account balances rather than pro rata among the shares of stock.

Rev. Proc. 2022-19 provides a new method for relief for nonidentical governing provisions. To qualify for relief, the S corporation and its shareholders must satisfy the following requirements:

* The corporation has or had one or more nonidentical governing provisions;

* The corporation has not made, and for federal income tax purposes is not deemed to have made, a disproportionate distribution to an applicable shareholder;

* The corporation timely filed (defined as filed within six months after its original due date, excluding extensions) a return on Form 1120-S, U. S. Income Tax Return for an S Corporation, for each tax year of the corporation, beginning with the tax year in which the first nonidentical governing provision was adopted and through the tax year immediately preceding the tax year in which the corporation made a request for corrective relief; and

* Before any nonidentical governing provision is discovered by the IRS, all of the requirements of the revenue procedure are satisfied.

To request relief, the corporation must prepare a statement of all the relevant facts, signed by a corporate officer, and each applicable shareholder must consent to the election. The corporation will prepare an explanation of how each nonidentical governing provision was discovered and each action taken to correct or remove it. To demonstrate reasonable cause for relief, the description must include each action taken by the corporation and each applicable shareholder to establish that the corporation and shareholder acted reasonably and in good faith in correcting or removing each nonidentical governing provision upon discovery.

Applicable shareholders include the corporation's current or former shareholders who own or owned stock of the corporation at any time during the period (1) beginning on the date on which the nonidentical governing provision was adopted and (2) ending on the date on which the nonidentical governing provision was removed or modified to comply with the one-class-of-stock requirement.

The IRS provides an example of a corporate governing provision statement in the revenue procedure's Appendix A and an example of a shareholder statement in...

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