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Be Careful Making an S election for an LLC

2024-05-06

If you make an S Election for an LLC, failure of the Operating Agreement to contain appropriate language to ensure that the entity operates according to the statutory requirements for being an S corporation causes an inadvertent termination of the S status.

The current IRS filing fee for retroactively fixing the termination and getting Section 1362 (f) IRC relief is $30,000.

In PLR 114424-23, 2024-04-19, all the members were eligible S corporation shareholders and LLC made an S election. The LLC operating agreement did not provide for identical rights to distribution and liquidation proceeds, which caused the LLC to have more than one class of stock under IRS Sec. 1061(b)(1)(D) so that the S election was ineffective.

Additionally, the LLC made disproportionate distributions to members during years 1, 2 and 3, which would have caused the S election to terminate, and a reorganization in year 4 would have otherwise caused the S election to terminate.

The PLR held that the termination was inadvertent and provided relief, and required the shareholders to take remedial steps to eliminate the cumulative amount of disproportionate distributions within 120 days.

Revenue Procedure 2022-19 Corrective Relief Statement,

Simple relief may be available under Revenue Procedure 2022-19, where the corporation had governing provisions resulting in more than one class of stock, but the corporation has NOT made and has NOT been deemed to have made disproportionate distributions, has timely filed forms 1120-S for each taxable year, and the IRS has not yet discovered the error.

Under the Revenue Procedure, the corporation must file a corrective relief statement, captioned “CORPORATE GOVERNING PROVISION STATEMENT PURSUANT TO REV. PROC. 2022-19, SECTION 3.06(2)(c)(ii)”.

The Corporate Governing Provision Statement must provide the following information:

  • The date of the Corporate Governing Provision Statement, the corporation’s name, employment identification number (EIN), address, date of formation or incorporation, and State of formation or incorporation;
  • The actual or intended effective date of the corporation’s S election filed on Form 2553 ( see Form 2553, Part I, line E) that is the subject of the request for corrective relief under this section 3.06;
  • The name, address, and social security number or taxpayer identification number of each applicable shareholder; and
  • To establish an inadvertent termination or invalidation of the S election of the corporation, a description of all relevant facts regarding why each non-identical governing provision was adopted, how each non-identical governing provision was discovered, and each action taken to correct or remove each non-identical governing provision before any non-identical governing provision is discovered by the IRS. This description must include each action taken by the corporation and each applicable shareholder to establish that the corporation and each applicable shareholder acted reasonably and in good faith in correcting or removing each non-identical governing provision upon discovery to demonstrate reasonable cause for relief.

And, except as provided in section 3.06(2)(c)(ii)(D), the corporation must provide the following four representations:

  • (“The corporation’s S election was inadvertently invalid or terminated solely because of the adoption of one or more non-identical governing provisions.”;
  • “The corporation and each applicable shareholder satisfy all of the requirements set forth in section 3.06 of Rev. Proc. 2022-19.”;
  • “The corporation responds in the negative to each requested statement set forth in section 7.01(4) or (5) of Rev. Proc. 2022-1, or any successor revenue procedure (statements regarding whether the same or a similar issue was previously ruled on or whether a request involving the same or a similar issue was submitted or is currently pending).”; and
  • “The corporation and each applicable shareholder acted reasonably and in good faith in correcting or removing each non-identical governing provision upon discovery.”.

The corporation must provide the statements set forth in section 3.06(2)(c)(ii)(E)( 1) through ( 3) of the revenue procedure:

  • “The corporation acknowledges that the relief provided by section 3.06 of Rev. Proc. 2022-19 is limited solely to each non-identical governing provision described in this Corporate Governing Provision Statement.”;
  • “The corporation acknowledges that the relief provided by section 3.06 of Rev. Proc. 2022-19 is based solely on the information, representations, and other statements provided by the corporation pursuant to section 3.06 of Rev. Proc. 2022-19, each of which is subject to verification during IRS examination.”; and
  • “During the period between the date on which the non-identical governing provision became effective
    and the date on which all of the procedures described in section 3.06 of Rev. Proc. 2022-19 are completed, each applicable shareholder has reported their income on all affected returns consistent with the S corporation election for the taxable year the non-identical governing provision became effective and for all subsequent years for which each applicable shareholder owned shares of the corporation.”.

The Shareholder must submit a Statement providing:

  • The date of the Shareholder Statement, the corporation’s name, EIN, address, date of formation or incorporation, and State of formation or incorporation;
  • The name and address of each applicable shareholder;
  • The social security number or taxpayer identification number of each applicable shareholder;
  • The number of shares of stock or, in the case of a limited liability company, percentage of ownership each applicable shareholder owns or owned and the date(s) the stock was acquired and, if applicable, transferred; and
  • The date that each applicable shareholder provided their signature, as required by section 3.06(2)(c)(iii)(D) of this revenue procedure.

Each applicable shareholder must provide the following statement of consent: “Under penalties of perjury, I declare that I consent to the election of [insert corporation’s name], referred to herein as “the Corporation,” located at [insert the Corporation’s address], whose employment identification number (EIN) is [insert the Corporation’s EIN], to be an S corporation under §1362(a)(1) of the Code. I have examined this consent statement, including accompanying documents, and, to the best of my knowledge and belief, the request for corrective relief contains all the relevant facts, and such facts are true, correct, and complete. I understand that my consent is binding and may not be withdrawn after the Corporation receives relief pursuant to Rev. Proc. 2022-19, section 3.06. I also declare under penalties of perjury that I have reported my income on all affected returns consistent with the Corporation’s election to be an S corporation for the taxable year for which the election would have been in effect but for the non-identical governing provision(s) described in the Corporate Governing Provision Statement for corrective relief and for all subsequent years I have owned shares of the Corporation.”.