s corporations – Wilson Rogers & Company

Electing S-Corp Status and Late Filing Relief

Filing Form 2553 is CRITICAL to being granted S-Corp status!

Every tax season we encounter some common issues and errors surrounding business owners who desire to be taxed as a S Corporation (S-Corp) by the IRS. What might those issues be? Well, usually one of the following:

Failing to make the S-Corp election entirely because they didn’t realize that Form 2553 needed to be filed with the IRS
Failing to make the election in a timely manner

In one of our previous posts we discuss the qualifications to become a S-Corp and some of the tax considerations. In this post, we are strictly going to discuss how to make the election and what to do if the deadline is missed.

When to Submit Form 2553

Form 2553 is used to tell the IRS that you want a corporation (or entity eligible to be taxed as a corporation, such as a single member LLC) to be taxed as a S-Corp. It is due:

No more than 2 months and 15 days after the beginning of the tax year the election is to take effect,
or at any time during the tax year preceding the tax year it is to take effect.

You can file the election at any time after thee above deadlines if your corporation meets the criteria for making a late S-Corp election (which we will discuss next).

It is important to note that the S-Corp election is made with the IRS, not the state. One is NOT changing their entity structure with the state. They are merely asking the IRS to tax the entity in a certain fashion. To help clarify what the election deadlines look like in practice, we’ve provided the following example:

Example 1 – New Corporation. New Corp, operates on a calendar year. It incorporated and began its first tax year on January 7th 2019. The 2-month period ends March 6th and 15 days after that is March 21st. To be a S-Corp beginning with its first tax year, it must file Form 2553 during the period that begins January 7th 2019 and ends March 21st 2019 (i.e. 2 months and 15 days after it incorporated). Because the corporation didn’t exist prior to January 7th, an election requesting an effective date prior to January 7th 2019 won’t be granted by the IRS.

Example 2 – New Corporation With Short Tax Year (less than 2 1/2 months). Short Corp, operates on a calendar year. It incorporated and began its first tax year on November 8th 2019. The 2-month period ends January 7th 2020 and 15 days after that is January 22nd 2020. To be an S corporation beginning with its short tax year, the corporation must file Form 2553 during the period that begins November 8th 2019 and ends January 22nd 2020. Because the corporation didn’t exist prior to November 8th, an election requesting an effective date prior to November 8th 2019 won’t be granted by the IRS.

Example 3 – Established Business. Old Corp, operates on a calendar year. It has been filing Form 1120 as a C corporation but wishes to make the S-Corp election for its next tax year (e.g. 2020) beginning January 1st. The 2-month period ends February 28th (the 29th in leap years) and 15 days after that is March 15th. To be a S-Corp in 2020, the corporation must file Form 2553 during the period that begins the first day (January 1st) of its last year as a C corporation (i.e. 2019) and ends March 15th of the year it wishes to be an S corporation (i.e. 2020). Because the corporation had a prior tax year, it can make the election at any time during 2019 but NO LATER than 2 months and 15 days beyond January 1st 2020 (i.e. the tax year the election is to be effective).

For the specific steps on when, where and how to submit your S-Corp election request, please refer to the Form 2553 Instructions per the IRS.

Requesting Relief for A Late S-Corp Status Election

So what happens if the deadline has passed to make the S-Corp election or you didn’t even know there was a deadline? Lucky for you, the IRS realizes that people makes mistakes and offers you some options to correct the oversight. They basically fall into the categories of:

Simply make the election effective for the NEXT year
Request relief stating that there was “reasonable cause”
Request relief using an IRS Revenue Procedure

Make the election effective next year. For those who miss the deadline, but don’t need it to be effective immediately, they can simply request that if be effective for the next year. For example, if you incorporate in late December 2019, but miss the March 15th 2020 deadline, you can always request that the election be effective for Tax Year 2021 by submitting Form 2553 prior to January 1st 2021.

Request relief on the grounds of reasonable cause. Reasonable cause refers to when a taxpayer didn’t file the forms on time due to a “valid reason” so to speak. In most cases, we’ve found the IRS to be fairly lenient when it comes to granting relief and allowing a corporation to elect S-Corp status in the year intended. Please note that reasonable causes may vary, and the IRS does not publish a list of what it considers to be one that is valid. However, there are numerous court cases that show that certain reasonable causes are “nearly always” allowed. Two of these typically include:

The company’s president, chief executive officer or similar responsible person neglected to file the election, or your corporation’s tax professional or accountant neglected to do so.
The corporation or its shareholders either did not know of the need to file an election or didn’t know they needed to file the election by a certain date.

If you are going to request relief on the grounds of reasonable cause, make sure that you address the following points within your statement:

What happened that caused the filing to be late and when did it happen?
How did these facts and circumstances result in the forms not being filed on time?
How did the company handle its financial and tax affairs during this time? Meaning, did they operate as if they were a S-Corp or did they delay individual income tax filings because they were intending to be a S-Corp?
What attempt did the company make to correct the situation when they learned they did not make the election correctly?

Request relief using an IRS Revenue Procedure. Rev. Proc. 2013-30 (PDF) facilitates the grant of relief to those who make a late S-Corp election. This procedure provides guidance for relief for late:

S corporation elections,
Electing Small Business Trust (ESBT) elections,
Qualified Subchapter S Trust (QSST) elections,
Qualified Subchapter S Subsidiary (QSub) elections, and
Corporate classification elections which the entity intended to take effect on the same date that the S corporation election would take effect.

Generally, the relief under the revenue procedure can be granted when the following requirements are met:

The entity intended to be classified as an S corporation, is an eligible entity, and failed to qualify as an S corporation solely because the election was not timely;
The entity has reasonable cause for its failure to make the election timely;
The entity and all shareholders reported their income consistent with an S corporation election in effect for the year the election should have been made and all subsequent years; and
Less than 3 years and 75 days have passed since the effective date of the election.

To assist in determining if an entity qualifies for late election relief, Rev. Proc. 2013-30 includes flow charts, as well as specific guidance for each of the five categories listed above.

If an entity does not qualify for relief under Rev. Proc. 2013-30, the entity may request relief by requesting a private letter ruling. The procedural requirements for requesting a letter ruling and the associated fees are described in Rev. Proc. 2019-1 (PDF). For more information on late election relief, check out this page on the IRS’ website.

Need help correcting a late S-Corp election? We’ve helped many companies that thought they filed their election or didn’t know they needed to file by a certain deadline obtain their desired S-Corp status. If you find yourself in this unfortunate predicament, you’re best advised to seek a professional who knows how to address the situation.

To that end, give us a call at 773-239-8850 or shoot us an email via the address contained in the footer of this page. The sooner you put us to work for you, the sooner you can have your election granted to you by the IRS!

2% Shareholders, S Corporations and Fringe Benefits

The IRS code section related to fringe benefits allows employers (in most cases) to deduct the cost of fringe benefits, while employees may exclude those amounts from their gross income. Employer paid health insurance costs are an example of such costs. However, while it seems like deducting health insurance premiums for a shareholder/employee of an S corporation should be a simple matter, only the tax law can make something that should be simple, complicated.

The problem goes back many years and arose soon after S corporations became part of tax law. Initially, S-corporations were viewed as similar to partnerships, and there was a prohibition on deducting certain fringe benefits of partners. Thus, a deduction was denied to S corporations for certain fringe benefits, most importantly health insurance, paid on behalf of S corporation shareholders. Well, not all shareholders, only those owning more than a 2% interest.

Approach. Health insurance of a 2% shareholder isn’t deductible by the corporation unless it’s included in the shareholder-employee’s income. Thus, the approach to make it a deductible expense by the corporation is to include the income on the shareholder’s W-2. At this point it’s a wash – the corporation gets a deduction and the shareholder has income (of course, the deduction is “passed through” to the shareholder). In the final step the shareholder deducts the premiums on his Form 1040, making the insurance premiums deductible.

Corporation or shareholder’s plan? What if the plan isn’t exactly 100% paid for by the corporation? The plan providing for coverage is established by the S corporation if:

The S corporation makes the premium payments for the health insurance policy covering the 2% shareholder-employee (and his or her spouse or dependents, if applicable) in the current taxable year, or
The 2% shareholder makes the premium payments and furnishes proof of the payment to the S corporation and the S corporation reimburses the shareholder-employee for the premium payments in the current tax year.

If the accident and health insurance premiums are not paid or reimbursed by the S corporation and included in the 2% shareholder-employee’s gross income, a plan providing medical care coverage for the shareholder is not established by the S corporation and the shareholder is not allowed the deduction.

In order for the shareholder to deduct the amount of the premiums, the S corporation must report the premiums paid or reimbursed as wages on the shareholder-employee’s Form W-2 in that same year. In addition, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040.

Examples. It always helps when one has an example to clarify the various scenarios that may be encountered. In the examples below, Goofball Inc. is an S corporation and Jeb and Bobbi Joe are 2% shareholder-employees.

In 2012 Jeb, a shareholder in Goofball Inc., obtains an accident and health insurance policy in his name and makes the premium payments on the policy. Goofball makes no payments or reimbursements with respect to the premiums. In this case a plan providing medical care for Jeb has not been established by the S corporation and Jeb is not entitled to the deduction under Sec. 162(l).
In 2012 Goofball obtains a health insurance plan in the name of Goofball. The plan provides coverage for Jeb, his spouse, and dependents. Goofball makes all the premium payments to the insurance company. Goofball reports the amount of the premiums as wages on Jeb’s Form W-2 for 2012 and Jeb reports that amount as gross income on Form 1040 for 2012. In this case a plan for providing medical care for Jeb has been established by Goofball and Jeb is allowed the deduction under Sec. 162(l).
For 2012, Bobbi Joe obtains a health insurance policy in her name. Goofball makes all the premium payments to the insurance company. Goofball reports the amount of the premiums as wages on Bobbi Joe’s Form W-2 and Bobbi Joe reports that amount as gross income on Form 1040. In this case a plan providing medical care for Bobbi Joe has been established by Goofball and Bobbi Joe is allowed the deduction under Sec. 162(l).
For 2012, Bobbi Joe obtains a health insurance policy in her name. She makes the premium payments to the insurance company and furnishes proof of premium payment to Goofball. Goofball then reimburses Bobbi Joe for the premium payments. Goofball reports the amount of the premiums as wages on Bobbi Joe’s Form W-2 and Bobbi Joe reports that amount as gross income on Form 1040. In this case a plan providing medical care for Bobbi Joe has been established by Goofball and Bobbi Joe is allowed the deduction under Sec. 162(l).

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