TAX: Failed to file proper Sub-S Election? IRS Proc. 2003-43

So...you are frustrated! Your sub-s company receives an IRS Notice and an IRS Letter from your accountant apologizing for an odd problem -- it appears that your IRS form 2553 (Election by a Small Business Corporation) was not received in time for this years taxes. Despite having filed the taxes timely, and sent appropriate K-1's, the IRS is now considering the company as a standard "C" corporation. This has devastating consequences for taxes and the treatment of corporate income.

You are not alone. Misfiled, lost, or not-filed elections are quite common in small business. If the IRS processes your company as a "C" corporation instead of an "S" corporation, the most obvious result is that pass-thru income is no longer a valid tool in your corporate tax tool-box. The firm itself will now owe taxes on the net income earned by the company. Individuals who received distributions from the company will still owe taxes on the amount earned. This is the cursed "double taxation" in corporate America, and the key reason for "S" corporation (and LLC's which were developed later, and receive the same tax benefits).

So what is the remedy? The IRS has several regulation that govern an "oops, I missed the filing of my election" situation. If you have a valid excuse (hard to imagine, but they do exist), then Revenue Procedure (Notice) 97-48 allows you to correct this without a direct ruling by the local district manager. If the error was inadvertent only (i.e. no excusable cause), file under Revenue Procedure 2003-43 which allows for a mistake in filing if you correct the error timely (24 months from the date the original election was due), and you are not behind on any of your corporate taxes. You will need to complete the form 2553, write across the top of form 2553 "FILED PURSUANT TO REV.PROC. 2003-43" and include (1) a statement that the filing is late because of an inadvertent filing error, (2) the principal of the business needs to sign a letter indicating that to the best of his/her knowledge, the corrected filing is accurate, (3) and each shareholder must sign that they understand and agree to the election of the Sub-S status dating back to the first taxable instance where such a status is desired.

What happens if your 2553 is rejected (after filing under REV.PROC. 2003-43)? You may always petition for a letter from the IRS director granting you an exception. These are generally granted, but unlike the 2553 avenue, you have to pay (I believe it is currently $180) for this letter ruling.

If you have questions or need help addressing a tax law question, please do not hesitate to contact us! We are experienced immigration, tax, and bankruptcy attorneys who can help with questions from any state in the US. S

Sean R. Hanover, Esq
HanoverLawPC.com
Contact Us ------------- SUMMARY OF THE CODE: In part, Rev.Proc 2003-43 reads: SECTION 1. PURPOSE This revenue procedure provides a simplified method for taxpayers to request relief for late S corporation elections, Electing Small Business Trust (ESBT) elections, Qualified Subchapter S Trust (QSST) elections and Qualified Subchapter S Subsidiary (QSub) elections. Generally, this revenue procedure provides that certain eligible entities may be granted relief for failing to file these elections in a timely manner if the request for relief is filed within 24 months of the due date of the election. Accompanying this document is a flowchart designed to aid taxpayers in applying this revenue procedure. . . . .02 Eligibility for Relief. Relief is available under section 4.04 of this revenue procedure if the following requirements are met: (1) The entity fails to qualify for its intended status as an S corporation, ESBT, QSST, or QSub on the first day that status was desired solely because of the failure to file the appropriate Election Under Subchapter S timely with the applicable service center; (2) Less than 24 months have passed since the original Due Date of the Election Under Subchapter S; (3) Either, (a) the entity is seeking relief for a late S corporation or QSub election and the entity has reasonable cause for its failure to make the timely Election Under Subchapter S, or (b) the S corporation and the entity are seeking relief for an inadvertent invalid S corporation election or an inadvertent termination of an S corporation election due to the failure to make the timely ESBT or QSST election and the failure to file the timely Election Under Subchapter S was inadvertent; and (4) Either, (a) all of the following requirements are met: (i) the entity seeking to make the election has not filed a tax return (in the case of QSubs, the parent has not filed a tax return) for the first year in which the election was intended, (ii) the application for relief is filed under this revenue procedure no later than 6 months after the due date of the tax return (excluding extensions) of the entity seeking to make the election (in the case of QSubs, the due date of the tax return of the parent) for the first year in which the election was intended, and, (iii) no taxpayer whose tax liability or tax return would be affected by the Election Under Subchapter S (including all shareholders of the S corporation) has reported inconsistently with the S corporation election (as well as any ESBT, QSST or QSub elections), on any affected return for the year the Election Under Subchapter S was intended; or (b) all of the following requirements are met: (i) the entity seeking to make the election has filed a tax return (in the case of QSubs, the parent has filed a tax return) for the first year in which the election was intended within 6 months of the due date of the tax return (excluding extensions), and (ii) all taxpayers whose tax liability or tax returns would be affected by the Election Under Subchapter S (including all shareholders of the S corporation) have reported consistently with the S corporation election (as well as any ESBT, QSST or QSub elections), on all affected returns for the year the Election Under Subchapter S was intended, as well as for any subsequent years. .03 Procedural Requirements for Relief. (1) Procedural Requirements When a Tax Return Has Not Been Filed for the First Year of the Intended Election Under Subchapter S. If the entity seeking the election has not filed a tax return for the first taxable year of the intended Election Under Subchapter S, the entity may request relief for the late Election Under Subchapter S by filing with the applicable service center the properly completed election form(s). The election form(s) must be filed within 18 months of the original Due Date of the intended Election Under Subchapter S (but in no event later than 6 months after the due date of the tax return (excluding extensions) of the entity (in the case of QSubs, the due date of the tax return of the parent) for the first year in which the election was intended) and must state at the top of the document "FILED PURSUANT TO REV. PROC. 2003-XX." Attached to the election form must be a statement establishing either reasonable cause for the failure to file the Election Under Subchapter S timely (in the case of S corporation or QSub elections), or a statement establishing that the failure to file the Election Under Subchapter S timely was inadvertent (in the case of ESBT or QSST elections.) (2) Procedural Requirements When a Tax Return Has Been Filed for the First Year of the Intended Election Under Subchapter S. If the entity seeking the election has filed a tax return for the first taxable year of the intended Election Under Subchapter S within 6 months of the due date of that tax return (excluding extensions), then the entity may request relief for the late Election Under Subchapter S by filing with the applicable service center the properly completed election form(s) and the supporting documents described below. The election form(s) must be filed within 24 months of the original Due Date for the Election Under Subchapter S and must state at the top of the document "FILED PURSUANT TO REV. PROC. 2003-XX." Attached to the election form must be a statement establishing either reasonable cause for the failure to file the Election Under Subchapter S timely (in the case of S corporation or QSub elections), or a statement establishing that the failure to file the Election Under Subchapter S timely was inadvertent (in the case of ESBT or QSST elections.) The following additional documents must be attached to the election form (if applicable): (a) S Corporations. An entity seeking relief for a late S corporation election must file a completed Form 2553, signed by an officer of the corporation authorized to sign and all persons who were shareholders at any time during the period that began on the first day of the taxable year for which the election is to be effective and ends on the day the election is made. The completed election form must include the following material: (i) Statements from all shareholders during the period between the date the S corporation election was to have become effective and the date the completed election was filed that they have reported their income (on all affected returns) consistent with the S corporation election for the year the election should have been made and for all subsequent years; and (ii) A dated declaration signed by an officer of the corporation authorized to sign which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."