How to Revoke S Corp Election Retroactively

An S corporation election allows a business to pass corporate income, losses, deductions, and credits to its shareholders for federal tax purposes. A business can voluntarily revoke its S election, but this change is prospective, not retroactive. For a revocation to be effective on the first day of the tax year, it must be filed by the 15th day of the third month of that year. If this deadline is missed, the revocation applies to the following tax year.

A retroactive change in tax status from an S corporation to a C corporation occurs when the S election is terminated unintentionally. This is known as an “inadvertent termination,” where the corporation can seek relief from the IRS to correct the error and preserve its S corporation status.

Grounds for Relief from an Inadvertent Termination

An inadvertent termination happens when a corporation unintentionally violates one of the S corporation eligibility rules, causing its S election to end. If the violation is not corrected, the business will be treated as a C corporation from the date of the terminating event. Common triggers include transferring stock to an ineligible shareholder (like a corporation, partnership, or non-resident alien), creating a second class of stock, or exceeding the 100-shareholder limit.

The IRS may grant relief if the corporation can show the termination was unintentional and that it has acted diligently to correct the mistake upon discovery. The corporation must demonstrate it had “reasonable cause” for the error and has taken steps to restore its compliance, such as having an ineligible shareholder sell the stock back to a qualifying individual.

Information Required for a Relief Request

To request relief from an inadvertent termination, the corporation must provide the IRS with a detailed explanation and documentation. The primary document is a formal affidavit, signed under penalties of perjury, explaining the “reasonable cause” for the terminating event. This affidavit must describe the event and explain why it was unintentional. Valid reasons could include relying on a tax professional who provided incorrect advice, the death or illness of a person responsible for tax compliance, or an honest mistake that was corrected upon discovery.

The explanation must show the corporation did not act with willful neglect or tax avoidance motives. The request must also include a statement signed by all shareholders who owned stock from the terminating event until the submission date. In this statement, shareholders must consent to any adjustments the IRS requires to restore the S election.

The Submission Process

A corporation must often request relief by applying for a private letter ruling (PLR) from the IRS. This is a formal process that requires paying a significant user fee, which can be several thousand dollars. The complete PLR request, including all affidavits and supporting documents, is sent to the IRS National Office for review, and the process can take several months.

However, the IRS has created a simplified procedure for certain common inadvertent terminations under Revenue Procedure 2022-19. A corporation may be able to self-correct without requesting a PLR or paying a user fee, provided it meets specific criteria. This simplified relief is available for errors related to ineligible shareholders and disproportionate distributions, as long as the issue is discovered and corrected within a reasonable period. If the situation does not qualify for this simplified procedure, the formal PLR process must be used.

Tax Filings After Relief Is Granted

If the IRS grants relief from an inadvertent termination, the corporation is treated as if its S election was never terminated. This approval validates the S corporation status for the entire period, avoiding a retroactive switch to a C corporation. The corporation should continue to file Form 1120-S for the tax years in question.

However, amended returns may be necessary for both the corporation and its shareholders. These amendments are not to change from S corp to C corp filings, but to reflect any specific adjustments the IRS required as a condition of granting relief. For example, if an ineligible shareholder received distributions, those amounts might need to be reclassified. Shareholders would then amend their personal returns (Form 1040-X) to align with the corrected corporate return and any adjusted Schedule K-1s they receive.