May 11, 2023

Late S Corp Election Guide (with Reasonable Cause Statement)

Contents

Ah, the S corporation election. 

You’ve probably heard that it can help you pay less tax. In some cases it can, while in other cases the incremental costs, employment taxes and time are less than the tax savings. 

Let’s assume that you’ve decided that an S corporation election is the way to go for your business. If so, making the election is a matter of filing Form 2553 with the Internal Revenue Service.

You need to file this form by March 15th of the year in which the S corporation election will be effective. If you miss this deadline you must make a “late election” which requires a few additional steps.

Let’s walk through the process of making a late S corp election.

What is an S corporation?

An S corporation is a business entity (LLC or Corporation) that has made a valid election with the IRS to be treated as an S corporation for tax purposes. An S corporation is not a legal business entity. It’s a tax status that the IRS confers upon a legal business entity.

A business may elect S corporation status for many reasons. 

An LLC owner can elect S corporation status to create a separate taxable entity in order to avoid self-employment taxes (employment taxes still apply). A corporation might elect S corporation status to avoid double taxation of dividends paid to its shareholders.

Unlike sole proprietorships, partnerships, or C corporations, the tax laws around S corporations are very cut and dry. The requirements specific to S corporations are that the S corporation:

  1. Must be an eligible business entity.
  2. Must pay shareholder-employees reasonable compensation.
  3. Must file a separate tax return, called the Form 1120-S.
  4. Must make distributions to shareholders based on ownership (no preferred shares).
  5. Must not have nonresident alien shareholders.
  6. Must adhere to state-specific rules.

It’s important to fully understand the S corporation requirements prior to making the election. Failing to adhere to the S corporation rules may result in the IRS revoking the S corporation status and assessing back taxes, penalties, and interest.

What is a late S corp election?

A late S corporation election is an election that’s made after March 15th.

Form 2553 is the form that you must file with the IRS to elect S corporation status for your LLC or corporation. You must file this form by March 15th of the year in which you intend to make the election effective.

For example, if it’s currently February 1st, then you’re making a timely election as long as you send Form 2553 to the IRS on or before March 15th. If you want the business to be taxed as an S corporation for the current tax year, and it’s currently May 21st, then you’re filing a late election.

In Rev. Proc. 2013-30, the IRS provides relief for businesses that fail to make a timely election due to reasonable cause. The basic requirements are:

  • The taxpayer intended to be classified as an S corporation as of the effective date,
  • The taxpayer requests relief under this revenue procedure within 3 years and 75 days after the effective date,
  • The failure to qualify as an S corporation was solely because the election under subchapter S was not timely filed by the due date of the election under subchapter S, and
  • The requesting entity has reasonable cause for its failure to make the timely election under subchapter S and has acted diligently to correct the mistake upon its discovery.

How to make a late S corp election

You can make a late S corporation election through the same process as a timely S corporation election, with a few additional steps.

Step 1: Download and complete Form 2553

You can download Form 2553 from the IRS website

You can complete most of it electronically except for collecting signatures from the business owners. Signature fields must be physically signed by all officers or other individuals responsible for tax matters. 

Refer to the Form 2553 instructions if you have questions about a specific line on Form 2553.

Step 2: Satisfy Rev. Proc. 2013-30 requirements

In Rev. Proc. 2013-30, the IRS outlines additional steps that must be taken to make a valid late S corporation election.

First, you must write “FILED PURSUANT TO REV. PROC. 2013-30” at the top of Form 2553.

Second, in Line I of Form 2553 you must prepare a reasonable cause statement that addresses each of the basic requirements established by Rev. Proc. 2013-30. See below for an example reasonable cause statement.

IMPORTANT: If you don’t include the late election header or reasonable cause statement with your Form 2553, the IRS may reject your election and you’ll need to start the process over.

Step 3: Send Form 2553 to the IRS

Form 2553 must be mailed or faxed to the IRS. Refer to the Form 2553 instructions for the mailing address and fax number.

If you’re mailing the form, I highly recommend using USPS certified mail. Certified mail requires a signature from the IRS upon delivery. It’s beneficial for late election purposes because it establishes (a) the date on which you mailed Form 2553 and (b) that the IRS in fact received Form 2553.

TIP: You can also file Form 2553 by attaching it to the business entity’s initial S corporation tax return (Form 1120-S). If you make the election with this method, you must note “INCLUDES LATE ELECTION(S) FILED PURSUANT TO REV. PROC. 2013-30” at the top of the tax return.

Step 4: Receive a confirmation letter from the IRS

The IRS will review the Form 2553 and mail a notice to the address listed on the Form 2553. 

If the IRS approves the S corporation election, you’ll receive Notice CP261 confirming the S corporation election effective date. Save this notice because there’s a good chance you’ll need it down the road, whether from your accountant or from the IRS. 

If the IRS rejects the S corporation election, you’ll receive CP 264 with an explanation of why the election was rejected.

Step 5: File an S corporation tax return and distribute Schedules K-1

Assuming the IRS approves the S corporation election, you’ll need to file a tax return (Form 1120-S) for the business entity. You must file Form 1120-S each and every year that the business entity is active, even if there was no financial activity, or until you or the IRS revokes the S corporation election. 

The tax return’s due date is March 15th unless you file an extension which grants an additional 6 months to file the tax return. 

You must file the S corporation tax return before filing your personal tax returns which are due on April 15th. Once the S corporation tax returns are filed, you’ll then distribute a Schedule K-1 to each shareholder on or before the original due date or the extended due date. 

Shareholders will need Schedule K-1 to prepare their personal tax returns. Schedule K-1 reports the shareholder’s respective share of the S corporation’s income, deductions, and other items on their personal tax returns.

What is “reasonable cause” for a late S corp election?

You must include a “reasonable cause” statement on Line I of Form 2553 to make a valid S corporation election. This statement should explain why you’re filing Form 2553 after the due date despite your intentions for the business to be treated as an S corporation.  

Reasonable cause includes being unaware of when and how to make a late S corporation election. It might also include relying on someone else, such as your accountant, to make the election but that person failed to file Form 2553 on time.

Reasonable cause does not include wanting to reduce your tax liability after the fact. 

You must have intended to be treated as an S corporation for the year in which the election becomes effective but forgot or otherwise neglected to make a timely election.

Example: Late S corp election reasonable cause statement 

The reasonable cause statement should address each of the four requirements for a valid late S corp election established in Rev. Proc. 2013-30. These requirements are listed above.

Here’s an example reasonable cause statement that would go on Line I of Form 2553. Use this as a starting point:

“The taxpayer was not aware of the requirement to make a separate election to treat a single-member LLC as an S corporation for federal tax purposes. The taxpayer intended to be treated as an S corporation effective January 1st, 20XX and began paying its shareholder(s) as employees in January 20XX. Once the taxpayer discovered the oversight, the taxpayer prepared Form 2553 to request late election relief.”

Preparing your reasonable cause statement

When submitting Form 2553, you’re certifying under penalty of perjury that all information on the form are true and accurate. You should tailor the statement to the business entity for which you’re making the election. 

For instance, if your business isn’t a single-member LLC, change this sentence to reflect your business’ legal entity status. Your business must be a domestic corporation or other domestic entity eligible to be treated as a corporation in order to make a valid S corporation election (e.g. a single- or multi-member LLC). 

You should also change the effective date to January 1st of the tax year in which the S corporation election will become effective. For example, if it’s June 15th and you want the entity to be taxed as an S corporation for the current year, you’d include January 1st of the current year in the reasonable cause statement.

You should also confirm that your business has in fact been operating as though it were an S corporation. For example, if your business hasn’t been running payroll for the business owners, then you should remove the verbiage around payroll. 

If you didn’t run payroll but otherwise took no distributions from the business, you can note that no shareholder distributions have been made for the current tax year. 

How to know if the late S corp election is approved?

If Form 2553 was accepted by the IRS, you’ll receive an official notice confirming the acceptance. This notice is the “CP261” letter. The IRS will mail it to the address you included on Form 2553. 

The CP261 letter will establish the effective date of your business’ S corporation election. Beginning with tax years starting on this date, your business will need to file Form 1120-S and begin running payroll for business owners.

Hold on to the CP261 letter. 

Your tax professional might ask for this letter to confirm that your business has in fact been approved for S corporation status. If there are ever any questions with the IRS about the S corporation election, this letter will help support your claim that an S corporation election was made and accepted.

You’ll also receive an IRS notice if your S corporation election was rejected by the IRS. This notice is the CP264

You’d likely receive CP264 if you applied for S corporation status for a particular tax year, but Form 2553 wasn’t filed on or before March 15th of that year. You can reapply for an S corporation election using the late S corporation election process outlined above.

If you haven’t received confirmation from the IRS that your S corporation election was approved or rejected, the IRS might still be processing your Form 2553. 

The IRS estimates that Form 2553 will take between 2-5 months to process. If this amount of time has passed, you can call the IRS to confirm whether the S corp election was accepted. The IRS doesn’t always mail the confirmation letters so it might take a follow-up call to receive confirmation. 

Once you’re speaking to an agent and you’ve confirmed acceptance, you can request an S corporation verification letter called the 385C to obtain official IRS documentation that the election was accepted.

Consult with a tax professional if you have questions

Making a late S corporation election isn’t difficult, but you need to carefully file the appropriate paperwork. Failing to include the correct information could result in your election being rejected. 

If you have questions about the election process, or other questions about S corporations, please get in touch through the contact form below. 

As a CPA who has made many successful S corporation elections for clients (including late elections), I can help your business make an informed decision and file the correct forms with the IRS to elect S corporation status.

This content is for informational purposes only and does not constitute legal, business, or tax advice. You should consult your own attorney, business advisor, or tax advisor regarding matters mentioned in this post. We take no responsibility for actions taken based on the information provided.

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