Page 431 - TaxAdviser_2022

CASE STUDY

Avoiding inadvertent

termination of an S election

Editor: If an S corporation fails to maintain
Shaun M. Hunley, J.D., LL.M. its status as a “small business corpora-
tion” under Sec. 1361(b), its S election Filing income tax
returns based on
automatically terminates on the date the
disqualifying event occurs. The disquali- an improper
fying events that can terminate S status
include the following (Secs. 1362(d)(2) year end is
and 1361(b)(1); Regs. Sec. 1.1362-2(b) not an event
(1)):
■ Having more than 100 shareholders. under Sec. 1362
The S corporation can have more that causes
A number of than 100 shareholders in total during
disqualifying events the year as long as there are no more disqualification.
can terminate a than 100 shareholders at any given
time.
corporation’s S ■ Having an ineligible shareholder impermissible tax year (Technical Advice
status, and not all of (e.g., a corporation, partnership, Memorandum 9505003). Sec. 1362 pro-
ineligible trust, or nonresident alien).
vides the specific events that can cause a
those events Partnership and corporate sharehold- corporation to fail to meet the definition
are listed in ers generally are not permitted, other of a small business corporation. Filing
the statute than so-called transitory ownership income tax returns based on an improper
as part of a corporate reorganization.
year end is not an event under Sec. 1362
or immediately ■ Having more than one class of that causes disqualification.
The IRS privately ruled that a corpo-
obvious. stock. Differences in voting rights ration that qualified as an S corporation
are allowed, which can be useful, for
example, when transferring nonvot- under Sec. 1361(b) prior to a state’s ad-
ing common stock to younger family ministrative dissolution (when the cor-
members or trusted employees. poration failed to timely file its annual
■ Becoming an ineligible corporation report and pay its annual license fee)
such as an insurance company was not required to file a new S election
or a domestic international sales under Sec. 1362(a) (IRS Letter Rulings
corporation. 9411040 and 200835002). Similarly, an
■ Transferring place of incorporation S corporation that did not know it had PHOTO BY COMSTOCK/STOCKBYTE/THINKSTOCK
This case study has been adapted from to a foreign country (thus no longer been administratively dissolved for the
Checkpoint Tax Planning and Advisory qualifying as a domestic corporation). nonpayment of fees was not required to
Guide’s S Corporations topic. Published
by Thomson Reuters, Carrollton, Texas, The IRS issued technical advice file a new election. The corporation had
2022 (800-431-9025; tax.thomsonreuters. stating that a corporation’s S elec- continued to file Form 1120-S, U.S. In-
com). tion was not terminated by using an come Tax Return for an S Corporation, and

48 August 2022 The Tax Adviser