But "S" corporation status comes with clear rules. The corporation seeking "S" status must make an election and all shareholders must consent to it. The election must be filed with the IRS at particular times. Until very recently, the rules were strictly enforced and any technical defect would result in the loss of "S" status - at least until the next tax year. But under a new statute which was enacted with retroactive effect, the IRS may treat a non-existent election for a tax year as timely if there was reasonable cause for the failure to file the election on time, As a result, the Service has shown increasing flexibility in granting "S" status to corporations which have not complied with the strict rules and has made the process of obtaining a ruling easier than it has been.
The procedural change constitutes a significant simplification. In the past, if "S" status was denied, the corporation's lone recourse was to request a private letter ruling, a process which was slow, technical, and expensive. But now a corporation may request relief just by writing to the local IRS Service Center within 6 months of the due date of the return for the first year in which the corporation intended to be an "S" corporation.
Some recent private letter rulings indicate that the new law has created a trend far from the strict enforcement of old:
A CPA prepared the election forms and sent them to the company's sole shareholder in enough time for the forms to have been filed timely. While the CPA told the shareholder to file the election as soon as possible, he did not give him a deadline. The shareholder had other things on his mind (one of which was a short trip abroad), failed to file the form on time, and sought relief on the ground of "reasonable cause." He succeeded.
A company's co-owner instructed his attorneys to prepare all the documents necessary to incorporate the company and make the "S" election. The attorneys formed the company but failed to prepare the election forms. This, too, constituted "reasonable cause" for a late election.
A company's two shareholders received advice from both their accountant and their attorney to operate the company as an "S" corporation, but nobody advised the shareholders that an election was necessary. The attorney blamed the accountant for this omission; the accountant blamed the attorney. While the finger pointing between the two of them must have been interesting, the IRS protected the interest of the client by finding "reasonable cause" for a late election.
Finally, an accountant sent a completed election form to the president of the company ... but the president never filed it. That, too, constituted reasonable cause.
While the new law has made the Service more flexible in its treatment of late elections, most taxpayers would prefer not to rely on the mercy of the IRS. The best way to avoid having to do that is to obtain competent advice from professionals who follow through with their clients to insure appropriate compliance. That's what we do. Small businesses of all kind are the very backbone of our practice. We would be pleased to serve you.