Rev Proc 98-19 for Invalid S Corp Elections

An S corporation election offers significant tax advantages, but strict rules govern its validity. When a business discovers its S corporation status was invalid from the start, the Internal Revenue Service (IRS) provides specific remedies, with modern procedures addressing the most common errors.

Revenue Procedure 2013-30 offers a simplified method for fixing late-filed S corporation elections. For inadvertent errors that made an S election invalid from its inception, such as having governing provisions that create a second class of stock, the appropriate guidance is Revenue Procedure 2022-19. For circumstances not covered by these specific revenue procedures, requesting a private letter ruling from the IRS remains an option.

Correcting an Invalid S Corporation Election

Relief is available when an S corporation election was filed late or was invalid from the start due to an inadvertent error. These procedures address mistakes made at the time of the election, not for a valid S corp whose status was terminated later. To qualify, the failure to perfect the S corporation election must have been inadvertent. This means the error was unintentional and not a result of willful neglect or a conscious decision to ignore the rules. The corporation must also show that it took prompt steps to correct the problem once it was discovered.

Late S Corporation Elections

If a corporation missed the filing deadline for Form 2553, Election by a Small Business Corporation, it may find relief under Revenue Procedure 2013-30. This procedure can validate the election if the corporation shows it had reasonable cause for filing late.

Inadvertently Invalid Elections

For an S election that was invalid from day one due to a defect, Revenue Procedure 2022-19 offers a way to retroactively fix the problem. This procedure primarily addresses errors in governing documents, like a shareholder agreement, that inadvertently create more than one class of stock.

To be eligible, the corporation and its shareholders must have consistently acted as if the S election were valid. This is indicated by consistent tax reporting, with shareholders reporting their share of items on personal returns and the corporation filing Form 1120-S. Relief is also conditioned on the circumstances not suggesting a tax avoidance motive by the corporation or its shareholders.

Required Documentation and Correction

To obtain relief under Revenue Procedure 2022-19, a corporation must take corrective actions and prepare documentation. The first step is to correct the error. If a governing provision was non-compliant, the corporation must amend the document to comply with S corporation rules, such as removing language that creates a second class of stock.

The corporation and its shareholders must also prepare signed statements.

Corporate Statement

An officer of the corporation must sign a statement under penalty of perjury. This document describes the error, explains that it was inadvertent, details how it was corrected, and affirms that the corporation and its shareholders have always filed tax returns consistent with S corporation status.

Shareholder Statements

Every person who was a shareholder during the period of the invalid election must also sign a statement under penalty of perjury. These statements confirm their consent to the S election and that they reported all income on their personal tax returns consistent with the corporation’s S status.

Finalizing the Correction

For relief under Revenue Procedure 2022-19, the corporation retains the corrective documents and signed statements in its corporate records. These documents are not automatically filed but must be provided to the IRS upon request.

A statement must be attached to the corporation’s Form 1120-S for the tax year in which the correction is made. This statement notifies the IRS that the correction was made under the authority of the revenue procedure.

If a situation is not covered by a specific revenue procedure, the corporation may need to request a private letter ruling. This is a more formal and costly process that involves a detailed submission to the IRS National Office. If approved, it provides the corporation with certainty that its S corporation status is secure, retroactive to the intended date.