IRS provides simplified measures for correcting common S corporation missteps

by | Oct 18, 2022

TAX ALERT | October 18, 2022

Executive summary: S corporation taxpayer assistance procedures

S corporations and their shareholders stand to benefit from taxpayer assistance procedures that allow them to quickly resolve several issues with S corporation elections frequently encountered during due diligence. The IRS provided the simplified procedures in Rev. Proc. 2022-19 on Oct. 11.

S corporation due diligence complexities

S corporations are subject to a litany of rules and restrictions, the violation of which can often result in catastrophic consequences—such as a loss of S corporation status. These issues often are not discovered until an S corporation goes through the due diligence process. Discovery of a foot-fault or misstep with respect to any of the stringent rules can sometimes require the expensive and time-consuming process of obtaining a private letter ruling, or PLR, to correct.

One of the most common issues in S corporation due diligence is proving that the company has a valid S election or Qualified Subchapter S Subsidiary election. The IRS has potentially made this process simpler in six different areas by recently issuing Rev. Proc. 2022-19, which provides simplified methods for relief without the need to request a PLR.

Of particular significance is the new administrative relief provision allowing S corporations and their shareholders to retroactively validate or preserve an S election that was either invalid or terminated as a result of a second class of stock caused by “non-identical governing provisions.”

Non-identical governing provisions historically have been a major issue for limited liability companies electing S status. Certain boilerplate LLC agreements can contain language that would provide for different liquidation or distribution rights, such as a provision requiring liquidating distributions to be made in accordance with positive capital account balances. Prior to the issuance of Rev. Proc. 2022-19, correcting such an issue would require the company to go through the process of obtaining a PLR.

Eligibility

Generally, to be eligible for retroactive relief for “non-identical governing provisions,” the following requirements must be met:

  • Existence of rights: The entity has or had one or more non-identical governing provisions
  • Identical timing and amount: All distributions to applicable shareholders, actual or deemed to occur, must be identical in timing and amount. 
    • An interesting aspect is that a differencing in timing but not amount would appear to disqualify taxpayers from qualifying for relief under these simplified procedures; however, it may not actually create a second class of stock for tax purposes. A common example here would be an S corporation that makes a final distribution each year to equalize shareholders.  
    • These provisions also may not hold the key to other common problems encountered around excessive compensation or utilization of company employees for individual purposes.
  • Timely filing: The corporation filed a return on Form 1120-S, before the original due date without extension plus six months, for each taxable year during the testing period.  The testing period runs from the year in which the first non-identical governing provision was adopted through the taxable year immediately preceding the year in which the corporation made a request for corrective relief; and
  • First to find: The taxpayer must fulfill the requirements of the Rev. Proc. prior to discovery of the non-identical governing provision by the IRS.

Procedure

If the S corporation is eligible for relief the corporation will be required to complete a “Corporate Governing Provision Statement,” and the shareholders will be required to complete a “Shareholder Statement.” These statements provide, among other things, an explanation of each non-identical governing provision adopted, how it was discovered, and the corrective action taken.

Other simplified procedures

The revenue procedure (Rev. Proc). goes on to provide “Taxpayer Assistance Procedures For Addressing Or Correcting” the five other issues identified in the revenue procedure, as well as detailing whether the IRS will rule (or will ordinarily rule) on the issue. Specifically:

  • Agreements and Arrangements with No Principal Purpose to Circumvent One Class of Stock Requirement – Examples include buy-sell agreements, transferability agreements, redemption agreements, debts agreements, etc
  • Governing Provisions That Provide for Identical Distribution and Liquidation Rights – If the governing instrument requires equivalency but actual distributions are different as to amount or timing the S election is not terminated
  • Procedures for Addressing Missing Shareholder Consents, Errors with Regard to a Permitted Year, Missing Officer’s Signature, and Other Inadvertent Errors and Omissions
  • Procedures for Verifying S Elections or QSub Elections
  • Procedures for Addressing a Federal Income Tax Return Filing Inconsistent with an S Election or a QSub Election.

These procedures, as well as a transition rule for pending PLRs, are all contained in Rev. Proc. 2022-19. There is hope that these simplified procedures will allow for speed and ease in due diligence and transactions, as well as reduce burdens on S corporations, their shareholders and tax professionals.

Questions or Want to Talk?

Call us directly at 972.221.2500 (Flower Mound) or 940.591.9300 (Denton),
or complete the form below and we’ll contact you to discuss your specific situation.


This article was written by Andy Swanson, Kyle Brown and originally appeared on 2022-10-18.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2022/irs-provides-simplified-measures-for-correcting-common-s-corporation-missteps.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

 

RSM

KHA Accountants, PLLC is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KHA Accountants can assist you, please call 972.221.2500.

Five Steps to Recognizing Revenue in Financials

The FASB and IASB have provided standards for properly recognizing revenue in your financials. Using a five step process, companies recognize revenue based on the value and timing of when control of the goods and services are transferred to the customer. Learn about the standards and how to properly recognize revenue for your company.

Is your managed service provider as secure as you think?

As attack methods become more sophisticated and widespread, no organization is immune to suffering a cybersecurity breach. The key to protecting your business is developing controls to make you less of a target and limit potential damage, as well as implementing a comprehensive strategy to react if you fall victim to an attack.