Making a New S Election Prior to the Expiration of the Five-Year Period
By Ehi Rajsky
In general, a small business may elect to become an S corporation by filing Form 2553 no more than two-and-a-half months following the beginning of the tax year in which the election is to take effect, or at any time in the tax year preceding the tax year the election is to take effect. In addition, a small business can revoke this election, thereby terminating it. If a small business making an S election revokes its election, the small corporation would not be eligible to make another election before the fifth taxable year following the first year that the revocation is effective, unless the Secretary consents to such election.
In a recent Letter Ruling, the IRS reviewed a small business whose shareholders A and B revoked and terminated its S Corporation election. Following the revocation, the shareholders sold a percentage of their shares to shareholders C, D, and E, who were all eligible S Corporation shareholders. Shareholders A and B's shares were respectively reduced by the percentage of their shares sold to the new shareholders, whose shares then totaled more than 50 percent of the small business's stock.
Upon admission of the new shareholders, the small business submitted a request for permission to make a new S Corporation election prior to the expiration of the five-year period described above.
According to the Internal Revenue Regulations, a corporation has the burden of establishing that, under the relevant facts and circumstances, the Commissioner should consent to a new election. Consent ordinarily is denied unless the corporation can show:
- The event causing the termination was not reasonably within the control of the corporation or its shareholders having substantial interest.
- It was not part of a plan of the corporation or such shareholders to terminate the election.
The fact that more than 50 percent of the small corporation's stock is owned by persons who did not own any stock in the small corporation at the time the S Corporation election was revoked could establish that consent should be granted.
Based on the facts represented above, the small business was granted permission to make the S election. Letter rulings are directed only to the taxpayer requesting them and may not be cited as precedent.