The IRS Makes it Easier and Cheaper to Fix Foot Faults on S-Corp Elections

During my career, I have assisted a number of taxpayers who have inadvertently terminated an S-Corporation election. Historically, fixing an inadvertent termination has been time consuming and expensive. The IRS fee for a private letter ruling can be as high as $38,000, and this cost alone results in many taxpayers deciding not to seek relief.

On October 7th, the IRS released Revenue Procedure 2022-19 which provides simplified measures for correcting six procedural missteps that the IRS says are resolvable without requesting a letter ruling. The IRS believes the relief provided in Rev. Proc. 2022-19 will reduce burdens on taxpayers and the government, facilitate increased taxpayer compliance with the rules for electing S corporation status, and reduce costs and delays in completing transactions involving S corporations and qualified subchapter S subsidiaries.

Sections 3.01 through 3.05 of the revenue procedure provide instructions on correcting five of the six foot faults that the IRS has historically treated as not affecting the validity or continuation of an S corporation or QSub election. They are:

1. Agreements or arrangements that don’t have a principal purpose of circumventing the requirement of only one class of stock. Because entering into these agreements or arrangements will not result in termination of S corporation status, taxpayers do not need to seek relief from the IRS and the IRS will not rule in these situations.
2. Disproportionate distributions made by S corporations with governing provisions that provide for identical distribution and liquidation rights. Because disproportionate distributions made in these circumstances will not result in the termination of S corporation status, taxpayers do not need to seek relief from the IRS and the IRS will not rule in these situations.
3. Missing shareholder consents, errors with regard to a permitted year, missing officer’s signatures and other inadvertent errors and omissions. The revenue procedure provides instructions for addressing these inadvertent errors.
4. Missing administrative acceptance letters for S corporation or QSub elections. The revenue procedure provides an address for requesting replacement acceptance letters.
5. Federal income tax return filings inconsistent with an S election or a QSub election. A corrected original return or amended return should be filed as soon as possible.

Section 3.06 addresses the sixth foot fault: S corporation elections that were inadvertently invalidated or terminated solely due to the adoption of one or more non-identical governing provisions. The term “non-identical governing provisions” refers to an entity with binding provisions regarding distribution and liquidation proceeds that result in the entity having more than one class of stock, even if the entity never made a non-pro-rata distribution or liquidating distribution. The S corporation must complete and retain a “Corporate Governing Provision Statement,” and the shareholders must complete and retain a “Shareholder Statement,” explaining why the nonidentical governing provisions were adopted, how they were discovered, and how they were corrected or removed. The revenue procedure’s appendix provides a sample of each statement and the statements must be made available to the IRS upon request.

The IRS has confirmed that these new self-help remedies for retroactively fixing invalid S corporation elections apply to limited liability companies that fail to update their operating agreement before filing an election.

For any questions on this or any other tax-related matters, please feel free to contact Joel Crouch at (214) 749-2456 or jcrouch@meadowscollier.com.