When is a QSub election considered timely filed?

Editor: Greg A. Fairbanks, J.D., LL.M.

Planning a reorganization of any entity is a complex endeavor requiring consulting with tax professionals and lawyers. There are many traps for the unwary requiring professional expertise to guide a corporation through a potentially once–in–a–lifetime event. However, even for experienced professionals, there are lots of unknowns in the law requiring a thoughtful plan to mitigate the risks while still achieving the client’s goals. One such risk is ensuring that the transaction steps are performed in the proper order and given effect so they are able to withstand an IRS audit that may occur years after the fact.

Background

An F reorganization under Sec. 368(a)(1)(F) is a tax–free corporate structuring that involves a mere change in identity, form, or place of organization of a single corporation. It is often used to facilitate changes such as converting a corporation to a limited liability company (LLC) or restructuring for private–equity transactions — without triggering immediate tax consequences.

In a typical F reorganization of an S corporation, a new corporation is formed, and the shareholders contribute the stock of the legacy S corporation into the newly formed corporation in exchange for all the stock of the newly formed corporation. The newly formed corporation then files a Form 8869, Qualified Subchapter S Subsidiary Election, (commonly referred to as a QSub election) on the legacy S corporation, effective as of the contribution date, to complete the F reorganization. See Situation 1 of Rev. Rul. 2008–18 as an example. It is common for the legacy S corporation to then convert to an LLC under state law to get rid of the corporate taint on the entity so that the legacy S corporation can be a partnership instead of a C corporation upon the addition of new unit holders or after being purchased by a new owner.

As long as the contribution and conversion of the legacy S corporation to an LLC occurs within a short period after the contribution, even without the QSub election, the steps generally should qualify as an F reorganization. However, in this scenario there is little guidance from the IRS on how long is too long between the contribution and conversion before it does not qualify as an F reorganization, and it is unclear if the legacy S corporation will retain its employer identification number (EIN) (see the ABA’s Comment letter, “Comments on Guidance on S Corporation F Reorganizations With a State Law Conversion to a Limited Liability Company,” (July 2, 2024) for additional information).

Rev. Rul. 2008–18 provides that if a QSub election is filed as part of an F reorganization, then the EIN of the legacy S corporation will remain with the legacy S corporation. While many argue the QSub election is not necessary for there to be an F reorganization, most practitioners recommend the QSub election step in order to ensure the EIN of the legacy S corporation does not transfer to the newly formed corporation. This is also a matter of administrative ease in reporting the transaction to the IRS so that the IRS updates its system with the proper records. The question then becomes how to make a proper QSub election, knowing the legacy S corporation will be converting to an LLC.

Several errors can occur in the filing of a QSub election, including using the wrong name, EIN, address, or even effective date. Each of these errors is potentially curable on its own through Rev. Proc. 2022–19. However, Rev. Proc. 2022–19 still likely requires certain items to be correct on the original filing, including that it is signed by a duly authorized officer of the new parent corporation and that it is timely filed.

The most common error in the transaction steps may be the timely filing of the QSub election. Regs. Sec. 1.1361–3(a) requires the legacy S corporation to meet all the requirements of Sec. 1361(b)(3)(B) at the time the election is made. Sec. 1361(b)(3)(B) requires (1) 100% of the stock of the legacy S corporation to be held by an S corporation and (2) that the S corporation elects to treat such corporation as a QSub. The requirement in Regs. Sec. 1.1361–3(a) that the corporation meet the requirements at the time the election is made is different from most elections that only require the entity to qualify as of the effective date of the election rather than the filing date of the election. In addition, while the Form 8869 can be filed at any time during the tax year, it cannot be effective more than two months and 15 days prior to the date of filing and cannot be effective more than 12 months after the date of filing (Regs. Secs. 1.1361–3(a)(3) and (4)). Thus, there is a narrow window after the contribution has occurred and before the state–law conversion is effective in which the QSub election must be filed.

The Code does not define the term “file” or “filed”; however, the courts have long held that in order to be considered “filed” the document must be delivered in the appropriate form to the specific individual or individuals identified in the Code or regulations (Helvering v. Campbell, 139 F.2d 865 (4th Cir. 1944); W.H. Hill Co., 64 F.2d 506 (6th Cir. 1933)). The burden is on the taxpayer to substantiate when the document is filed. The general rule for when a document is considered filed is when it is received by the IRS at the place where it is required to be filed (i.e., the received date) (see also Allnutt, 523 F.3d 406 (4th Cir.
2008),aff’g T.C. Memo. 2002-311; Miller, 784 F.2d 728 (6th Cir. 1986); Hotel Equities Corp., 546 F.2d 725 (7th Cir. 1976), aff’g 65 T.C. 528 (1975)).

The mailbox rule is an exception to the received date to allow for certain documents to be deemed filed on the mailing date under certain facts and circumstances. Sec. 7502, more commonly referred to as the mailbox rule, provides the rules on when an election that is required to be filed is considered made. (Note that a common–law mailbox rule differs from the codified mailbox rule in Sec. 7502. The codified mailbox rule applies to federal returns and elections that are required to be filed, such as the QSub election.) Sec. 7502 provides that if certain requirements are met, then the date on which a return, claim, statement, or other document is mailed is the date it is deemed to be filed for federal income tax purposes.

Generally, for Sec. 7502 to apply, the document must be:

• Required to be filed within a prescribed period or on or before a prescribed date under authority of any provision of the internal revenue laws;
• Properly addressed;
• Timely deposited in the mail in the United States (special requirements if mailing from outside the United States are not covered here); and
• Received after the prescribed period or prescribed date.

Each of the requirements of Sec. 7502 provides a unique set of issues and risks in filing Form 8869 under the given facts.

What is the prescribed period for filing Form 8869?

Sec. 7502 requires that the document, Form 8869 under our facts, be filed within the prescribed period. The “prescribed period” is not defined within the Code or regulations but rather relates back to the Code or regulations requiring the particular form to be filed. Defining the prescribed period to file a return is easier. For example, Regs. Sec. 1.6037–1(b) specifies that Form 1120–S, U.S. Income Tax Return for an S Corporation, is due on or before the “15th day of the third month following the close of the taxable year.” Sec. 7701(a)(23) defines “taxable year” as the calendar year, or the fiscal year ending during such calendar year. Therefore, the prescribed date for filing Form 1120–S for a calendar–year taxpayer is generally March 15. Applying Sec. 7502 means that if Form 1120–S is mailed on or before March 15 but arrives at the proper IRS address after March 15, the mailing date will be the filing date, assuming the other requirements of Sec. 7502 are met.

For Form 8869, Regs. Sec. 1.1361-3(a)(3) provides the time for making the QSub election is “any time during the taxable year.” As Sec. 7701(a)(23) defines “taxable year” as the calendar year or the fiscal year ending during such calendar year, does this mean that if the contribution occurs on Dec. 30 for a calendar-year-end taxpayer that the form must be filed by Dec. 31? This interpretation is supported by Section 4.01(2) of Rev. Proc. 2013-30, which states that the due date of the election is specified in Regs. Sec. 1.1361-3(a)(3).

The IRS campus applies the “prescribed period” in relation to the effective date and ignores the “taxable year” language included in the regulations (see Internal Revenue Manual (IRM) §3.13.2.24.3 (effective Jan. 1, 2025)). Just be warned there is at least some level of risk in the effectiveness of a QSub election if Form 8869 is filed after the end of the corporation’s tax year in which the election is to be effective. It may be prudent to request late election relief under Rev. Proc. 2013–30 on Form 8869 if it is filed after the S corporation’s tax year end.

Where is it required to be delivered?

One of the requirements of Sec. 7502 is that the envelope be properly addressed. If the envelope is not properly addressed, then Sec. 7502 does not apply and it will not be deemed filed until the election is transferred to the proper location by the IRS (Allnutt, 523 F.3d at 412—13 Seaview Trading, LLC, 62 F.4th 1131 (٩th Cir. 2023) (en banc), aff’g T.C. Memo. ٢٠١٩–١٢٢). In most instances, this means even an election timely placed in the mail but addressed to the incorrect IRS location for processing will not be “filed” until after the “prescribed period” is over, as it can take months for the IRS to transfer the election to the proper IRS location for processing.

Regs. Sec. 1.1361–3 and the Form 8869 instructions provide the election is to be filed at the service center where the most recent return of the subsidiary was filed, and if the S corporation forms a new subsidiary, then the election should be filed in the service center where the parent S corporation last filed a return. There are two items of note in the regulations and form instructions. The first is that Form 8869 could be sent to one of several service centers across the country, depending upon the facts (typically, Ogden, Utah, or Kansas City, Mo., based on the current form instructions). The second item of note is that the regulations and form instructions specify it must be sent to a “service center.”

There are no instructions if the prior return was electronically filed. As Form 8869 cannot be electronically filed, practitioners commonly take the position that it should be filed with the service center where the most recent return would have been filed if it had been paper–filed.

Another quirk is where to deliver if mailing using the U.S. Postal Service (USPS) versus a private delivery service such as United Parcel Service or FedEx. The USPS will deliver to the service center, and there are no instructions providing a delivery address using USPS other than the service centers.

However, for using a private delivery service to file a tax return, the tax return is supposed to be delivered to a different address than the service center. The return form instructions provide a link to a web address to which a return is to be delivered using private delivery services. The web address provides an address that is not the service centers’ (it even names them “submission processing centers” rather than the regulatory language of “service center”), but the form instructions provide it does meet the “timely mailing as timely filing” rule for tax returns. It is unclear if this address can also be used for a Form 8869 filing, since it is not a tax return or a service center. As the regulations and form instructions require delivery to a service center, it is unclear where to mail Form 8869 using a private delivery service. It may be best practice to mail Form 8869 to the service center and the private delivery service addresses.

Under IRM Section 3.13.2.24(3) (effective Jan. 1, 2025), the IRS will process a Form 8869 if it is faxed. However, the Form 8869 instructions do not provide fax instructions or a fax number to which it can be submitted. The Form 1120–S instructions also do not provide a fax number to which the tax return can be filed. Form 2553, Election by a Small Business Corporation, does provide instructions on how to file Form 2553 via fax. As Regs. Sec. 1.1361–3 and the Form 8869 instructions do not provide faxing as an appropriate method of filing, it is not recommended to rely upon a fax to meet the requirements of Regs. Sec. 1.1361–3. In addition, there have been issues with the IRS accepting a fax receipt as proof of filing, since the Service does not confirm receipt. This author has found faxing the form to be very effective if I already have proof of timely filing and the Form 8869 was never actually processed or was processed incorrectly by the IRS.

What is proof of depositing in the mail?

The third requirement of Sec. 7502 is proof of mailing. There is case law of taxpayers filing their returns and the IRS never receiving the filing or of the IRS losing the envelope from which the proof of mailing could be obtained. The taxpayer has the burden to prove that the form was mailed, and the courts have had mixed reactions on what proof is required. It is not uncommon for a court to consider a self–serving affidavit as not having much weight without other credible support.

If the taxpayer is filing using USPS, certified mail with a domestic return receipt is the best mailing method. The certified mail item should be stamped by the Postal Service when it is accepted. This is the proof of timely mailing that is required for Sec. 7502 purposes. A taxpayer or practitioner cannot self–certify by adding the postage to the letter. The Postal Service also allows senders to track the progress of the letter using the certified mail number on the USPS website.

For a private delivery service, the IRS issued Notice 2016–30, which provides the exclusive list of private delivery services that are acceptable for Sec. 7502 purposes. The list is very specific; for example, FedEx 2 Day is acceptable, but FedEx Ground is not. Thus, verifying the acceptable mailing type is necessary prior to shipping. In order to prove the form was timely placed in the mail, a copy of the mail receipt and, likely, a printout of the tracking record is required. There is little guidance on what evidence a court may require as proof of filing by a private delivery service, but an affidavit from the private delivery service on receipt of the package may be necessary. Note that a private delivery service is required to maintain the records for only six months.

Does the state-law conversion change the prescribed period for filing Form 8869?

In order for Sec. 7502 to apply, Form 8869 must be received after the prescribed period or prescribed date. In the case of Form 8869, there is not a simple answer to what is the prescribed period, providing for probably the single greatest risk to a timely filed Form 8869 in an F reorganization transaction. There is a risk that the state–law conversion will take place before Form 8869 is “filed,” resulting in an ineffective QSub election. Without the application of Sec. 7502, many of the QSub elections filed today as part of an F reorganization would not be proper elections. While it is clear if the conversion under state law occurs before Form 8869 is “filed” that it is not a good QSub election, it is not clear whether the state–law conversion shortens the period for filing under Sec. 7502 so that Sec. 7502 applies.

In order for Sec. 7502 to apply, the election must be received after the prescribed period or prescribed date. Just because an entity no longer qualifies to be a QSub does not mean that the period in which to file the election is also shortened when the regulations provide clear guidance that the election must be filed within the two–month–and–15–day period. The additional requirement to also qualify at the time of filing may not be sufficient to change the two–month–and–15–day period requirement for Sec. 7502 purposes.

If using USPS, it is highly recommended to also use a domestic return receipt, which requires the IRS to sign the receipt upon delivery. This offers undeniable, direct proof of the IRS’s actual receipt. The downside of this method of mailing is that it frequently takes a month or more to receive the domestic return receipt. Keep in mind that courts have not litigated whether a scan of a certified mail receipt is acceptable (instead of the actual original).

For private delivery services, the same issues with providing proof of depositing the form in the mail also apply to proof of delivery. A printout record of the tracking information should be maintained by the taxpayer.

In conclusion, in planning an F reorganization with a legacy S corporation followed by a QSub election, there are a number of factors to consider to ensure the QSub election is effective. Depending upon the facts, there may be a substantial risk that Sec. 7502 does not apply to the QSub election, but with proper planning, the risk of an ineffective QSub election can be minimized.

Editor

Greg Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington, D.C.

For additional information about these items, contact Fairbanks at greg.fairbanks@us.gt.com.

Contributors are members of or associated with Grant Thornton LLP.