Request for Guidance Regarding Making Proper S Corporation Consents of Form 2553, Election by a Small Business Corporation
| Publication year | 2021 |
| Author | By John C. Miles and Eric D. Swenson |
(Clarifying Who and How to Sign the Form 2553 "Consent Statement" for Grantor Trust Shareholders and Community Interest Spouse Shareholders)1
By John C. Miles and Eric D. Swenson2
Corporations which qualify as "Small Business Corporations" pursuant to Internal Revenue Code ("IRC")3 Section 1361(b) may elect to be treated as an "S Corporation" if certain requirements are met. The election to be treated as an S Corporation (the "S Election") is made on Form 2553, Election by a Small Business Corporation ("Form 2553").4
One such requirement for a valid S Election is that "all shareholders in such corporation" must consent to the S Election.5 This consent is generally completed in Part 1, Sections J through N, inclusive, of the Form 2553 (the "Consent Statement"). The authors believe that additional guidance is needed to enable taxpayers to consistently and accurately complete the Consent Statement in a manner that will be accepted and further respected by the IRS and, sometimes more importantly, relied upon by others who, for instance, as a buyer, are relying upon the valid S Corporation status when acquiring stock of such intended target "S Corporation."6
The negative consequences of an ineffective or invalid S Election can be severe. The issue regarding the validity of the original S Election due to a poorly or incorrectly prepared Form 2553 is generally not discovered for years, or even after decades, have passed. One such negative consequence is that a corporation with an ineffective S Election is, in fact, taxed (or should have been taxed) as a C corporation (with all of the associated C corporation tax liabilities from previous open tax years still outstanding). All of the shareholders of such corporation would have received K-1's used to prepare their individual income tax returns, which individual income tax returns will also be incorrect if the S Election was invalid.
Grantor Trust Shareholders. When S Corporation stock is owned by a trust that is treated as owned by an individual who is a citizen or resident of the United States under subpart E of part I of subchapter J of chapter 1 of the IRC (a "Grantor Trust"), the Form 2553 does not provide entirely clear instructions (the "Instructions") as to: (1) which party should be identified or listed as the "shareholder;" and (2) how the remainder of the Consent Statement should be completed (in a variety of scenarios). While the Instructions state that the shareholder "required to consent" should be listed in Column J, and Treas. Reg. Section 1.1362-6(b)(2)(iv) states that only the person treated as the shareholder of the S Corporation must consent (i.e., generally an individual as the deemed owner, not the Grantor Trust as the shareholder of record) the Form 2553, Part I, Election Information, instructs that the "shareholder" be identified in Column J and provides a reference to "(see instructions)." In the authors' experience, many of those completing the Form 2553 do not understand, for whatever reason, that the term "shareholder" for the purpose of entering the shareholder name in Column J is not always the actual shareholder of record (e.g., when a Grantor Trust is the shareholder of record, the person or persons treated as the owner should be entered).
For the purpose of assisting those preparing complete and accurate Forms 2553, the authors propose: (1) updating Column J of Form 2553 to list "deemed shareholder" as a possible party written in Column J; (2) a "check box" on each shareholder line in Column J of the Consent Statement to help prompt or remind individual shareholders or deemed owners to list their individual name even if the shareholder of record is his or her Grantor Trust; and (3) additional detail and an example in the Instructions demonstrating a best practice for how the deemed owner of a Grantor Trust should consider completing the Consent Statement.
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Spouse Owning a Community Property Interest. In the case of a spouse that owns solely a community property interest in S Corporation stock, in the authors' experience, many taxpayers, again for whatever reason, are not aware that such community property spouses must also consent to the S Election, even though the Treasury Regulations and Instructions make it very clear. Similar to the above situations for Grantor Trusts, the authors propose: (1) updating Column J of Form 2553 to list "deemed shareholder" as a possible party written in Column J; (2) a "check-box" on the Form 2553, Part I, Election Information, in Column J on each shareholder line of the Consent Statement to prompt shareholders to identify spouses with solely a community property interest; (3) additional detail in Column L of the Instructions to provide that spouses with a community property interest should enter -0- shares owned; and, (4) additional detail and an example in the Instructions demonstrating a best practice for how a spouse with solely a community property interest in shares should consider completing the Consent Statement.
At the end of this proposal, we provide a "redline" of our proposed changes to the Form 2553 and its Instructions. See Proposal, III.D, Final Proposed Changes.
A. Small Business Corporations—Overview
1. In General
IRC Section 1362(a) permits Small Business Corporations to affirmatively elect to be treated as S Corporations. A Small Business Corporation is a domestic corporation which is not an "ineligible corporation" and does not: (A) have more than 100 shareholders;
(B) have as a shareholder a person (other than an estate, a trust described in Section 1361(c)(2), or an organization described in Section 1361(c)(6)) who is not an individual;
(C) have a nonresident alien as a shareholder; or (D) have more than one class of stock." (Emphasis added.)7
2. A Trust as a Shareholder
A Small Business Corporation shareholder must be: (1) an individual; (2) an estate; (3) one of certain trusts permitted by IRC Section 1361(c)(2); or (4) an organization described by IRC Section 1361(c)(6) (i.e., generally an IRC Section 501(c)(3) entity).
The following trusts are certain of the trusts that are permitted as shareholders of a Small Business Corporation:
i. Grantor Trusts.
A trust which is treated (under subpart E of part I of subchapter J of chapter 1 of the IRC) as owned by an individual who is a citizen or resident of the United States (i.e., a Grantor Trust).8 In the case of such a trust, the "deemed owner" shall be treated as the shareholder (emphasis added).9
ii. Trusts Held at Death.
A trust which was a Grantor Trust immediately before the death of its deemed owner, but only for the 2-year period beginning on the day of the deemed owner's death.10 In the case of such a trust, the estate of the deemed owner "shall be treated as the shareholder."11
iii. Testamentary Trusts.
A trust with respect to stock transferred to it pursuant to the terms of a will, but only for the 2-year period beginning on the day on which such stock is transferred to it.12 In the case of such a trust, the estate of the "deemed owner" shall be treated as the shareholder.13
iv. Voting Trusts.
A trust created primarily to exercise the voting power of stock transferred to it.14 In the case of such a trust, "each beneficiary of the trust shall be treated as a shareholder."15
v. ESBT.
An electing small business trust ("ESBT").16 In the case of an ESBT, "each potential current beneficiary . . . shall be treated as a shareholder."17 If there is no current potential beneficiary for a period, the trust shall be treated as the shareholder during such period.18
vi. QSST.
A trust which qualifies as a qualified subchapter S trust ("QSST").19 A QSST generally requires that, during the life of the current income beneficiary, there be only one (1) income beneficiary of the trust, and that all of the income of the trust be distributed to the beneficiary at least annually.20
B. Consent Statements—Background
An S Election is only valid if all shareholders of a Small Business Corporation on the date the S Election is made consent to such S Election.21 The S Election is not valid without a valid Consent Statement from each of the shareholders.22 The Consent Statement must be in the form of a written statement and must set forth, "[1] the name, address, and taxpayer identification number of the shareholder, [2] the number of shares of stock owned by the shareholder, [3] the date (or dates) on which the stock was acquired, [4] the date on which the shareholder's taxable year ends, [5] the name of the S Corporation, [6] the corporation's tax identification number, and [7] the election to which the shareholder consents." (Numbering and emphasis added.)23
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Each Consent Statement must also be signed by the shareholder under penalties of perjury.24
1. Consent Statement—Trusts Eligible to Own S Corporation Stock
When stock in a Small Business Corporation is owned by a trust described in IRC Section 1361(c)(2)(A)(i) (i.e., a Grantor Trust), including a QSST but excepting an ESBT, "only the person treated as the shareholder of the S Corporation . . . must consent to the election."25
2. Consent Statement—Community Interest in S Corporation Stock
When stock in a Small Business Corporation is owned by a husband and wife as community property, or if the income from the stock is community property, or is owned by tenants in common, joint tenants, or tenants by the entirety, each person having a community interest must consent to the S Election.26
C. Issues and Consequences with an Ineffective S Election
1. Certain of the Tax Consequences of an Ineffective S Election
If a Small Business Corporation filed a Form 2553 and intended to make an effective S Election, when in fact it has not (as a result of an incorrect or incomplete Consent Statement), the consequences can be far reaching.
First, the tax classification of...
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