The NYU 76th Institute on Federal Taxation (IFT) is taking place in New York City on October 22-27, 2017, and in San Francisco on November 12-17, 2017. This year, I will be presenting my latest White Paper, The Built-in Gains Tax Revisited. My presentation will include a discussion about the history of the tax; application and impact of the tax; ways to avoid or potentially minimize the tax; the complexities of Code Section 1374 and the regulations promulgated thereunder; valuation issues; planning opportunities; traps that exist for the unwary; relevant cases and rulings; and practical tax practitioner guidance.
The IFT is one of the country's leading tax conferences, geared specifically for CPAs and attorneys who regularly are involved in federal tax matters. The speakers on our panel include some of the most preeminent tax attorneys in the United States, including Jerry August, Terry Cuff, Wells Hall, Karen Hawkins, Stephen Looney, Stephen Kuntz, Mark Peltz and Bobby Philpott. I am proud to be a part of IFT.
This will be my fifth year as an IFT presenter, and I am speaking as part of the Closely Held Business panel on October 26 (NYC) and November 16 (San Francisco). As in previous years, the IFT will cover a wide range of fascinating topics, including tax controversy, executive compensation and employee benefits, international taxation, corporate taxation, real estate taxation, partnership taxation, taxation of closely-held businesses, trusts and estates, and ethics.
I hope you will join us this year for what will be a terrific tax institute. Looking forward to seeing you in either New York or San Francisco!
View the complete agenda and register at the NYU 76th IFT website.
The Service Continues its Warm Approach to Taxpayers with S Corporation Inadvertent Terminations (PLR 201340001)
As we know, in accordance with Code Section 1362(f) and the corresponding Treasury Regulations, a corporation will continue to be treated as a Subchapter S corporation during a period of termination, if:
- The election was terminated, either because the corporation was disqualified as an electing small business corporation, or as a result of running afoul of the passive investment income rule;
- The Service determines the termination as inadvertent;
- The corporation promptly takes steps to correct the defect after discovery; and
- The corporation and its shareholders acted as if the election was continuously in effect.
Continuation of an S election following an inadvertent termination is ultimately within the Secretary’s sole discretion. Unfortunately, taxpayers must request a ruling to obtain relief. Treas. Reg. Section 1.1362-4(c). The good news, however, is that the Service routinely issues affirmative rulings in this area.
Private Letter Ruling 201340001 (October 18, 2013) is an example of the Service issuing inadvertent termination relief. In this private letter ruling, shares of the taxpayer were transferred to a trust which was an ineligible shareholder. The next day, the taxpayer discovered the problem and immediately caused the shares to be transferred to an eligible shareholder. The Service, in its ruling, emphasized that the taxpayer represented that:
- Its shareholders at all times since the effective date of the S election treated the corporation as an S corporation;
- The termination was not motivated by tax avoidance or retroactive tax planning;
- The eligible shareholder who ultimately received the shares reported all items of the taxpayer’s income, loss, deduction and credit that would have been allocated to the ineligible trust shareholder, and the eligible shareholder paid all taxes associated therewith; and
- The taxpayer’s shareholders agreed to make any adjustments required by the Secretary.
Based upon these representations, the Service granted relief to the taxpayer. While a private letter ruling is only binding on the Service and the taxpayer who obtains it, this ruling is a good reminder to practitioners that relief may be granted under Code Section 1362(f) for inadvertent S corporation terminations. The keys to obtaining an affirmative ruling in the advertent termination area appear to be fourfold: (i) the termination was inadvertent; (ii) prompt curative action was taken after discovery of the error; (iii) the shareholders acted consistently with the election being in continuous effect; and (iv) the absence of any tax avoidance motives.
If you are faced with an inadvertent S corporation termination because the corporation no longer qualifies as an electing small business corporation or due to violating Code Section 1362(d)(3) (excessive passive investment income), you may be able to obtain relief under Section 1362(f). A ruling request, however, will be required.
To qualify as an S Corporation for the current tax year, a corporation must make an election: (1) at any time during the entity’s preceding tax year; or (2) at any time before the 15th day of the 3rd month of the current tax year. If a corporation fails to make a timely election, it is considered a “late S election” and it will not qualify as an S Corporation for the intended tax year.
The consequences of a late S election or failing to file an S election can be severe. First, the corporation will be taxed as a C Corporation and subject to corporate income taxes. Second, the corporation may be subject to late filing and payment penalties, and interest on unpaid taxes. Finally, if the corporation filed IRS Forms 1120S as if it were an S Corporation, then all prior tax years would be subject to IRS examination because the tax years remain open.
Prior Revenue Procedures
In 1996, Congress recognized the failure to timely file an S election could lead to severe consequences and gave the IRS authority to issue rules providing relief for late S elections. In 1997, the IRS issued Rev. Proc. 97-40 and Rev. Proc. 97-48. In later years, the IRS expanded late filing relief in Rev. Proc. 98-55, Rev. Proc. 2003-43, Rev. Proc. 2004-48, and Rev. Proc. 2007-62.
Generally, these Revenue Procedures applied to late S corporation, Electing Small Business Trust, Qualified Subchapter S Trust, and Qualified Subchapter S Subsidiary elections. The requirements were fairly straightforward and each subsequent Revenue Procedure expanded the leniency for late elections.
Rev. Proc. 2013-30
Effective September 3, 2013, Rev. Proc. 2013-30 simplifies how to obtain late filing relief and increases the time period for which retroactive relief may be obtained.
Pursuant to Rev. Proc. 2013-30, the time period for which retroactive relief may be obtained for late S elections is extended to 3 years and 75 days after the intended effective date of the S election. Revenue Procedure 2013-30 also provides similar relief for late:
Qualified Subchapter S Trust elections;
Electing Small Business Trust elections;
Subchapter S Subsidiary elections; and
Corporate classification elections.
The requirements for relief in these situations are similar to the requirements discussed below for late S elections. However, there are some differences. If you are faced with any of these late filings, a careful review of Rev. Proc. 2013-30 is required.
Late S Election Relief Requirements
To obtain relief for a late S election, the corporation must file IRS Form 2553 and include at the top of the form “FILED PURSUANT TO REV. PROC. 2013-30.” In addition, the following requirements must be satisfied:
- Late filing is the sole defect;
- The entity qualified as an S Corporation for the period relief is sought;
- The entity intended to be an S Corporation;
- The request for relief is filed within 3 years and 75 days after the intended effective date of the S election;
- The request for relief contains a statement describing why reasonable cause exists for the late election and the entity acted diligently to correct the mistake upon discovery; and
- All shareholders reported their income on all affected returns consistent with an S election in effect and statements from all shareholders attesting to this must be attached.
There is also relief available if the request is made more than 3 years and 75 days after the intended effective date of the S election. In such instances, in addition to satisfying the above requirements, the following requirements must be met:
- At least 6 months have elapsed since the corporation filed its IRS Form 1120S for the first tax year it intended to be an S Corporation;
- Neither the corporation nor any shareholder was notified by the IRS of any problems regarding S Corporation status within 6 months of the filing of its IRS Form 1120S for the first tax year it intended to be an S Corporation; and
- The entity is not seeking a late entity classification election (e.g., an LLC that “checks-the-box” to be taxed as a corporation and then makes an S election).
While most of the requirements are objective in nature, an entity must demonstrate reasonable cause as to why a timely S election was not filed. This is a subjective inquiry.
Historically, the IRS has placed a low threshold on the reasonable cause requirement. Examples of situations where the IRS has found reasonable cause include: (1) the entity’s responsible person failed to file the S election; (2) the entity’s tax professional failed to file the S election; and (3) the entity did not know it needed to affirmatively file an S election.
Prior IRS Forms 1120S
If the corporation has filed all IRS Forms 1120S for tax years it intended to be an S Corporation, IRS Form 2553 requesting late filing relief can be attached to the current tax year’s IRS Form 1120S, provided the forms are filed within 3 years and 75 days from the intended effective date of the S election. An extension of time to file the current tax year’s IRS Form 1120S will not extend the 3 year and 75 day period.
No Prior IRS Forms 1120S Filed
If the corporation has not filed an IRS Form 1120S for the tax year it intended to be the effective date of the S election, then IRS Form 2553 requesting late filing relief may be attached to IRS Form 1120S for the first intended S Corporation tax year, provided:
- IRS Form 1120S for the intended effective date of the S election must be filed less than 3 years and 75 days from the intended S election date; and
- All other delinquent IRS Forms 1120S must be filed simultaneously and consistently with the requested relief.
Rev. Proc. 2013-30 greatly expands the situations where late filing relief may be available.
If you discover an S election was not filed or was not timely, there may be hope. If you don’t qualify for assistance under Rev. Proc. 2013-30, relief may still be available through a private letter ruling. This process, however, is time consuming and costly.
Click here for flowcharts contained of Rev. Proc. 2013-30. They are excellent tools to navigate through Rev. Proc. 2013-30.
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Planning Using IRC Section 1031 Exchanges," Oregon Society of Certified Public Accountants (OSCPA) Forest Products ConferenceEugene, OR, 6.22.18
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Summer Institute in Taxation – Advanced Conference on Subchapter SNew York, NY, 7.26.18-7.27.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationNew York, NY, 10.21.18-10.26.18
- "The Tax Cuts and Jobs Act – What It May Mean to Your Clients," Estate Planning Council of Portland Mini-SeminarPortland, OR, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18