S corp. relief.

• Author: Smith, Greg W.
• Position: Tax deductions available to S corporations

Consider the following (all too familiar) facts.

Example: Individuals A and B come to a CPA's office on Jan. 31, 1999, and inform him that they incorporated XYZ Corporation on Jan. 1, 1999, to operate their business. The business is expected to incur $400,000 in tax losses for its first year. A and B want to receive flowthrough treatment for XYZ's operations to allow them to deduct immediately operational losses for the first few years; once XYZ becomes profitable, they want to remove themselves from the double-tax regime of subchapter C. The CPA prepares Form 2553, Election by a Small Business Corporation, and sends it to XYZ with a cover letter stating that it must be filed within the standard 2 1/2-month time period (i.e., by Mar. 15, 1999).

While preparing XYZ's first income tax return in February 2000, the CPA reports the $400,000 in losses on its S return (fully offsetting other income of A and B). When attempting to retrieve a copy of the Form 2553 to attach to the S return, it is discovered that the form is missing. After calling XYZ's management to obtain a copy of the signed election form, the CPA learns that they forgot to file the election. As a result, A and B owe $150,000 in taxes (which they do not have) and the $400,000 of losses incurred in 1999 will be trapped in the C corporation until it becomes profitable and can use them.

Help has arrived in the form of Rev. Proc. 98-55, detailing relief procedures for late S elections when reasonable cause can be demonstrated. Rev. Proc. 98-55 applies to late elections of S corporations, qualified subchapter S subsidiaries (QSubs), electing small business trusts (ESBTs) and qualified subchapter S trusts (QSSTs).

For late S and QSub elections, taxpayers will receive automatic relief if (1) they make the election within 12 months of the original election due date (but not later than the original due date of the S return, excluding extensions) and (2) reasonable cause can be demonstrated. In the case of late ESBT and QSST elections, taxpayers will receive automatic relief if (1) they make the election within two years of the original election due date and (2) reasonable cause can be demonstrated. Rev. Proc. 98-55 amplifies Rev. Proc. 94-23 (specifically for late QSST elections) and supersedes Rev. Proc. 97-40 (specifically for late S elections made within six months of the original due date).

"Reasonable cause" is not defined in Rev. Proc. 98-55. However, based on informal (i.e...