For years, the Internal Revenue Service (IRS) has known that many limited liability companies (LLCs) make invalid S corporation elections or terminations due to a procedural misstep. About 80 S corporations apply to the IRS for administrative relief each year, but most impacted companies don't even ask because it's prohibitively expensive to request relief for these foot faults. But the IRS has finally created a new way for impacted S corporations to fix the filing on their own. There's even an opportunity to apply for retroactive relief.
New Foot Fault Eligible for Relief
The new guidance covers an entity that loses its S corporation election because of accidental “non-identical governing provisions.”
Under the tax law, S corporations can have only one class of stock.
But some entities have binding provisions regarding distribution and liquidation proceeds. This requirement inadvertently results in creating more than one class of stock.
These inconsistent governing provisions invalidated the entity's election to be an S corporation. That's been true, even if the company never yet made a non-pro-rata distribution.
However, the IRS has now said that it will allow entities to correct this inadvertent invalidation retroactively.
The New Relief
Under the new policy, S corporations can now file a Corporate Governing Provision Statement, with a related shareholder statement, to obtain relief. To be eligible, all of the following must apply:
- The corporation has at least one non-identical governing provision
- The corporation hasn't yet made any disproportionate distributions
- The corporation filed the Form 1120-S tax return required for S corporations during the time that the provision existed
- The corporation and shareholders corrected the statements before the IRS discovered the error
While there is some uncertainty in the new guidance, the policy appears to apply to LLCs with an S corporation election. This is significant because LLCs often have boilerplate language in their organization documents that presume—incorrectly—that the LLC will operate (and be taxed) as a partnership. This can now be fixed in a comparatively easy fashion.
If you are unsure if your entity is eligible for relief or want to apply, don't wait. If you need help, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.