Electing S status by an LLC

An existing entity (such as a limited liability company (LLC) classified as a partnership) can elect under the check-the-box rules to be classified as a corporation. If the election is made, the entity is deemed to transfer all of its assets and liabilities to the corporation in exchange for the corporation’s stock. The entity is then deemed to distribute the corporation’s stock to its owners in complete liquidation (Regs. Sec. 301.7701-3(g)(1)). The deemed transfer to the corporation is tax-free, assuming Sec. 351(a) applies and the LLC’s liabilities do not exceed the basis of its assets (Sec. 357(c)).

An LLC or other entity that has filed a check-the-box election to be taxed as a corporation can elect S status if the entity and its shareholders meet the S corporation eligibility requirements (Regs. Sec. 1.1361-1(c); see also Regs. Sec. 301.7701-3).

Deemed election to be treated as a corporation

An LLC that is eligible to elect S status and timely files an S election (Form 2553, Election by a Small Business Corporation) is considered to have made the election to be taxed as a corporation (Regs. Sec. 301.7701-3(c)(1)(v)(C)). These entities are not required to file Form 8832, Entity Classification Election. Other entities file the election to be taxed as a corporation on Form 8832 in accordance with Regs. Sec. 301.7701-3(c).

Under Regs. Sec. 301.7701-3(c), the effective date of the classification election specified on Form 8832 cannot be more than 75 days prior to the date on which the election is filed and cannot be more than 12 months after the date on which the election is filed. This means that the classification change can be retroactive for up to 75 days before the Form 8832 is filed. Under the S corporation rules, however, a newly formed corporation must file the S election on or before the 15th day of the third month following the activation date of the corporation, which is the earliest date that the corporation: (1) has shareholders; (2) acquires assets; or (3) begins conducting business. If the entity plans to make the election to be treated as a corporation and become an S corporation on the same date, only Form 2553 is filed, and it should conform to the S corporation rules. The authors recommend that the Form 2553 be filed by the earlier of 75 days or two months and 15 days after the date the S election is to become effective. In this way, the Form 2553 will be filed within both the Form 8832 and Form 2553 filing limits.

Planning tip: An LLC that is making the election to be treated as a corporation and become an S corporation on the same date is not required to make the election at the first of the calendar year. Rather, the election can be retroactive or prospective within the time limits surrounding the date the Form 2553 is filed, as outlined above. (Allowing an LLC to make a midyear S election makes sense because a newly electing S corporation can begin its first S year at any allowable date.) To conform to the S corporation rules, however, the effective date of the S election should not occur before the earliest date that the LLC has members, acquires assets, or begins conducting business.

Effective period of deemed election to be treated as a corporation

An entity that makes the deemed election to be taxed as a corporation by filing the S election, Form 2553, will be classified as a corporation on the date the S election is effective and will continue to be treated as a corporation until it makes another entity classification (Regs. Sec. 301.7701-3(c)(1)(v)(C)). If an entity elects to change its classification, it cannot change its classification again during the 60 months after the effective date of the election without IRS permission (Regs. Sec. 301.7701-3(c)(1)(iv)). Before such a change in classification takes place, the planner must carefully consider the tax effects of the change. For example, the reclassification of a corporation to a partnership under the check-the-box regulations is a complete liquidation of the corporation (Regs. Secs. 301.7701-3(g)(1)(ii) and (iii)).

Filing Form 2553 when an LLC elects S status

It can be confusing when an LLC completes the S election Form 2553 because no actual incorporation takes place and no shares are issued. The instructions to the Form 2553 offer some guidance on how to fill out the Form 2553 under these circumstances, though they do not divulge how an LLC shows the effective date or state of incorporation. It would seem logical to show the effective date of the Form 8832 (if one is filed) as the “date incorporated” on Form 2553. If Form 8832 has been filed, the authors recommend that a copy of the Form 8832 be attached to the Form 2553, along with an explanatory statement stating that the entity has made the check-the-box election and is now making the S election. If Form 8832 is not filed, the effective date of the S election could be entered. The state of incorporation is the state where the entity was formed. The instructions say that the “Number of Shares” and “Date(s) Acquired” sections of Form 2553 should show each individual’s percentage of ownership and the date (or dates) acquired.

Example 1. Electing entity status under the check-the-box regulations: A and B each own 50% of X, a newly formed LLC. The owners want the entity to be treated as an S corporation for tax purposes, and they confirm that the company is eligible to make the S election.

If no election is made, the default classification is to operate the multi-member entity as a partnership. However, the owners want X to be classified as an S corporation. The S election is made by filing Form 2553 rather than Form 8832. By properly filing a valid Form 2553, the entity elects S status and is deemed to have elected to be classified as an association taxable as a corporation.

Example 2: Now assume that the owners want X to operate as a regular C corporation. Here, the entity files Form 8832 to make the classification election. If the corporation elects S status in a subsequent tax year, it will file Form 2553 at that time.

Effect of invalid Form 2553

As discussed earlier, it is not necessary to file both Form 8832 for a newly formed entity to elect to be treated as an association taxed as a corporation and Form 2553 to elect S corporation status. Instead, a single election can be made on Form 2553. A timely filed Form 2553 will constitute a deemed entity classification election, as if Form 8832 were filed. However, this deemed entity classification election is effective only if the electing entity meets all of the requirements to be an S corporation. Form 2553 also is not effective if the entity fails to qualify as an S corporation as of the election date (Regs. Sec. 301.7701-3(c)(1)(v)(C)).

This means that if the S election is invalid because the S requirements are not met, the entity will be treated as a C corporation only if a valid Form 8832 has been filed. Thus, an entity that wants to operate as an LLC classified as a partnership in the event the S election fails should file Form 2553 and not Form 8832. Conversely, if the entity wants to operate as a C corporation if the S election fails, it should file a Form 8832 and not a Form 2553. Because these are two specific elections, they should be submitted separately to the appropriate addresses.

If Form 8832 is filed, a copy should be attached to the entity’s return (Form 1120-S, U.S. Income Tax Return for an S Corporation) for the year that the entity classification election is to be effective. This copy does not have to be signed. Failure to attach Form 8832 to the tax return does not invalidate the election, but if it is not attached, penalties may apply (see Regs. Sec. 301.7701-3(c)(1)(ii) and instructions to Form 8832).

Relief provisions when Form 8832 or Form 2553 is not timely filed

In Rev. Proc. 2013-30, the IRS provides a simplified method for requesting relief when an entity that intended to be classified as an association taxable as a corporation on the date the S election became effective failed to timely file Form 2553 (and Form 8832, if required).

Relief under this procedure allows an entity that fits the requirements to be an S corporation from the date it originally intended to elect S status, even though the form(s) were not timely filed. Reasonable cause must be given for the failure to timely submit the Form 2553 or both forms. No user fee is required when applying for relief under these revenue procedures.

Relief under this revenue procedure is available when Form 2553 (or Form 8832, if that form should have been filed) is late. Rev. Proc. 2013-30 allows the entity to elect S status by filing Form 2553. The election can be filed with the current Form 1120-S if all earlier Forms 1120-S have been filed, or attached to the first Form 1120-S for the year including the intended effective date if filed simultaneously with any other delinquent Forms 1120-S. Form 2553 can also be filed separately. The forms must be filed within three years and 75 days after the original intended effective date of the election. The information and statements required by Rev. Proc. 2013-30 and additional statements relating to a late corporate classification election (required by Rev. Proc. 2013-30, Section 5.03) must be submitted with the Form 2553. If this revenue procedure is followed, Form 8832 is not required to be filed; only Form 2553 and the required statements need to be submitted.  

This case study has been adapted from PPC’s Tax Planning Guide: S Corporations, 33d edition (March 2019), by Andrew R. Biebl, Gregory B. McKeen, and George M. Carefoot. Published by Thomson Reuters, Carrollton, Texas, 2018 (800-431-9025; tax.thomsonreuters.com).