Tax Relief Blog
IRS website provides guidance on S corporation election problems
Filing Requirements for Filing Status Change, on IRS website
Mike Habib, EA
myIRSTaxRelief.com
In a recent posting on its website, IRS explains the steps to be taken and forms to be filed by taxpayers requesting to change their filing status from a C Corporation (filing Form 1120) to an S Corporation (filing Form 1120S). In particular, IRS explains what to do if a taxpayer hasn’t timely filed Form 2553, and either has or hasn’t filed Form 1120S for the first year of the intended S corporation election.
Background. S corporations are incorporated entities with many of the same attributes as traditional C corporations, including limited liability, transferable ownership, and unlimited life. But unlike C corporations, S corporations are generally not subject to income tax. Instead, the business’s profit or loss is passed through to the shareholders, who report it on their individual returns. To qualify, a corporation must elect S corporation status and meet a number of requirements. It can have no more than 100 shareholders, and only certain types of taxpayers can be shareholders. It can have only one class of stock.
Taxpayers elect S corporation status by filing Form 2553, Election by a Small Business Corporation, on or before the 15th day of the third month of the tax year for which the election is to be in effect.
Observation: Among other issues, the Tax Advocate’s 2007 Report to Congress highlighted problems with the S corporation election process. If the election isn’t timely filed or is incomplete, the S corporation return is converted to a C corporation return when filed. In past years, roughly 14% to 16% of total new S corporation filings were unpostable (i.e., the S corporation election was not approved). Approximately 20% of S corporation returns are unpostable for multiple years because of missing information or IRS processing errors.
C corporation requesting change to S corporation. A taxpayer requesting to change its filing status from a C corporation to an S corporation should timely fax or mail a paper copy of Form 2553 to the appropriate Service Center (as directed in Form 2553 instructions). The corporation will receive an acknowledgment and approval of the S corporation election. If it doesn’t, it should follow-up with the Service Center where the Form 2553 was filed. The taxpayer should file (electronically, if required) its last C Corporation return (Form 1120) by the due date or extended due date.
Finally, the taxpayer should file (electronically, if required) an S corporation return (Form 1120S) by the due or extended due date. The filing of the initial Form 1120S return finalizes the change of the entity’s filing requirement on IRS’s records.
Failure to timely file Form 2553. If a taxpayer hasn’t timely filed its election request to be treated as an S Corporation, it generally must request relief for the late election by requesting a private letter ruling and paying a user fee. However, certain relief provisions are available, as discussed below.
Where Form 1120S has been filed. If a taxpayer hasn’t timely filed Form 2553, but has timely filed Form 1120S for the first year of the intended S corporation election, its Form 1120S can’t be accepted and processed by the Service Center. When the Service Center notifies the taxpayer of the invalid S election, it should file a paper copy of Form 2553 with the Service Center, writing at the top of the form “Filed pursuant to Rev. Proc. 2003-43,” and attaching a statement establishing reasonable cause for the failure to timely file Form 2553. The Form 2553 and attached statement should be mailed to the Service Center separate from any other returns or information being submitted. (Taxpayers not eligible to use Rev Proc 2003-43, 2003-23 IRB , must generally request a private letter ruling and pay a user fee.) The taxpayer should file (electronically, if required) the last C Corporation return (Form 1120) by the due or extended due date.
Where Form 1120S hasn’t been filed. If a taxpayer hasn’t timely filed Form 2553 and also hasn’t filed Form 1120S, it can choose one of two options. (Taxpayers not eligible to use either option must generally request a private letter ruling and pay a user fee.) Under the first option, the taxpayer files a copy of Form 2553 with the initial Form 1120S within 6 months of the due date of the Form 1120S (excluding extensions). On Form 2553, it provides a statement establishing reasonable cause for the failure to timely file Form 2553.
Under the second option, the taxpayer mails or faxes a paper copy of Form 2553 with the appropriate Service Center, writing at the top of the form “Filed pursuant to Rev. Proc. 2003-43,” and attaching to Form 2553 a statement establishing reasonable cause for the failure to timely file Form 2553. The Form 2553 and attached statement should be mailed to the Service Center separate from any other returns or information being submitted. The Form 2553 should be filed before filing of the Form 1120S, and the Form 1120S should not be filed until the taxpayer is notified that the S election has been accepted.
Finally, under both options, the taxpayer should then file (electronically, if required) the last C Corporation return (Form 1120) by the due or extended due date.
