Tax ARTICLE - S Corporation Election Filing

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A corporation elects to operate as an S corporation by filing Form 2553 (Election by a Small Business Corporation). Once made, the S election remains in effect until it is voluntarily or involuntarily terminated [IRC Sec. 1362(c)]. Changes in ownership of S corporation stock have no effect on the S election, so long as all of the stock is owned by individuals or other entities eligible to be S shareholders. The deadline for filing the Form 2553 differs depending on whether the corporation is already in existence (i.e., operating as a C corporation) or newly formed.

Existing Corporations

For an existing C corporation electing S status, the election must be filed during the tax year preceding the first tax year the S election is to be effective, or on or before the 15th day of the third month of the initial S year. When an existing corporation becomes an S corporation, S status begins on the day following the last day of the C corporation’s tax year.

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Newly Formed Corporations

For a newly formed corporation, the election must be filed on or before the 15th day of the third month following the “activation date” of the corporation. The regulations indicate that the activation date is the earliest date that the corporation has shareholders, acquires assets, or begins conducting business. Care must be taken to ensure that the S election is not filed before the corporation is in existence (i.e., before the charter or articles are registered with and authorized by the Secretary of State in the state of incorporation). Both IRS regulations and case law hold that an S election is not valid if the corporation is not in existence at the time the election is filed. The S corporation’s first tax year begins on its activation date.

The S Election Is Made on Form 2553

To make the election to become an S corporation, Form 2553 is filed with the IRS. Three separate compliance matters occur with the filing of this form: (1) the election of the corporation to adopt S status, (2) the consent of all the shareholders of the corporation, and (3) selection of the S corporation tax year. If not made on Form 2553, a shareholder consent can be made on a separate statement, which must be signed by the shareholder and include the name, address, taxpayer identification numbers of the corporation and the shareholder, the number of shares owned by the shareholder, the date of stock acquisition, and the date on which the shareholder’s tax year ends. Shareholder consent is binding and may not be withdrawn after a valid election is made by the corporation.

Persons Required to Consent to the S Election

All persons who are shareholders on the date the S election is filed must consent to the election. Consents are also required from anyone who held shares at any time from the beginning of the tax year through the day the S election is filed. Shareholders who acquire stock after the S election is filed need not consent to the S election.

The following rules apply in determining who is required to consent to the S election:

Spousal Ownership. Each person having a community interest in the stock (or income there from) and each tenant in common, joint tenant, and tenant by the entirety must consent to the election
Minor. A minor or the minor’s legal representative must consent to the election. If no legal representative has been appointed and the minor cannot sign or is otherwise unable to consent, the consent is made by the minor’s natural or adoptive parent.
Estate. The consent of an estate must be made by an executor or administrator thereof, or by any other fiduciary duly appointed and having jurisdiction over the administration of the estate. In the case of a bankruptcy estate, the trustee consents to the S election.
Trust. For a trust [other than an electing small business trust (ESBT)] that is an eligible S corporation shareholder, the persons treated as shareholders for purposes of the 100-shareholder limitation must consent to the election. For married shareholders, both husband and wife must consent to the election if they have a community interest in the trust. The trustee of an ESBT consents to the election.
Family Ownership. Effective for tax years beginning after December 31, 2004 , all family members can elect to be treated as one shareholder for purposes of determining the number of shareholders in the corporation.

Obtaining Relief from Omitted Consent of Community Property Spouse

Automatic relief is available if the S election Form 2553 does not include the signature of a community property spouse who was a shareholder solely because of the state’s community property law. Also, a sample community property consent and a protective consent to use if the stock is considered to be the separate property of one spouse are furnished at Election E101.

Beneficial Owner

The registered owner of S corporation stock might not be the beneficial owner (i.e., the person or entity that controls the stock or reaps the benefits of stock ownership). In that event, the beneficial owner, rather than the owner of record, is considered to be the shareholder (i.e., the owner of the S corporation stock). Thus, a beneficial owner of stock must consent to the S election.

Shareholders Acquiring Stock after the S Election Is Filed

Shareholders who acquire stock after the election is filed are not required to consent to the S election. However, if the IRS grants an extension of time to submit consents, a consent must be made by all persons who (1) were shareholders at any time during the period beginning on the date the election was filed and ending on the extended date for obtaining the consents, and (2) have not previously consented to the election.

Deadline for Filing Shareholder Consents Can Be Extended

The IRS has authority to waive the effects of an invalid S election or accept an S election filed after the 15-day-of-the-third-month deadline has expired. Likewise, the deadline for obtaining a particular shareholder’s consent to the S election can be extended with the approval of the IRS.

Consequences If Form 2553 Is Not Properly Filed

Failure to timely or properly file the S election could have severe consequences to the shareholders. While the corporation can normally qualify for S status for the following year, even a one-year postponement could be detrimental.