Is your S election really late.

For many years the IRS has been denying taxpayers S status when their S elections were not timely filed. Previously, when taxpayers requested relief based on a legitimate reasonable cause argument, they were flatly turned down by the Service. The IRS'S position was that the deadline for filing an S election was statutory and could not be waived.

In 1996, Congress finally gave taxpayers an opening. Under the Small Business Job Protection Act of 1996 (SBJPA), Sec. 1362(b)(5) was added, granting the Service the authority to treat any election not timely filed as timely made, if the IRS determined there was reasonable cause for such failure.

Since the enactment of the SBJPA, the Service has issued notices and revenue procedures providing methods to obtain expedited waiver approval. Two of the most recent are Rev. Procs. 9740 and 97-48. Rev. Proc. 97-48 granted automatic relief if a taxpayer's facts met certain criteria. (Rev. Proc. 97-48 was discussed in detail in the May 1998 issue of The Tax Adviser, p. 309.)

Under Rev. Proc. 97-40, the IRS is not so generous. This procedure replaces the letter ruling approach of Sec. 1362(b)(5). Relief is provided only if certain factual criteria are met and the taxpayer establishes to the Service's satisfaction that reasonable cause leading to the taxpayer's failure to timely file its perfected S election existed. Rev. Proc. 97-40 applies only to corporations that have not filed a timely S election in accordance with Sec. 1362(a)(1) and (2). In addition, the following requirements must be met for a corporation to be eligible for relied

1. The corporation must otherwise qualify as an S corporation in accordance with the provisions of Sec. 1361;

2. Tile corporation must file a perfected S election within six months of the original due date under Sec. 1362(b)(2); and

3. The due date (excluding extensions) for the tax return for the first year the corporation intended to be an S corporation must not have passed.

To request relief under this procedure, a corporation must file with the applicable IRS service center a completed Form 2553, Election by a Small Business Corporation (Under section 1362 of the Internal Revenue Code), within six months of the original due date of the S election. The top of the form must state "FILED PURSUANT TO REV. PROC. 97-40." The form must be signed by a corporate officer and all persons who were shareholders at any time during the period beginning with the first day the election is to be effective through the day the election is made. A statement explaining the reason for the late S election is to be attached to the form when filed. The Service will determine if reasonable cause for the late Selection existed and notify the corporation of its determination.

Note: Rev. Proc. 97-40 does not provide guidance as to what would be considered reasonable cause. However, the INS is generally following the standards it previously set forth in granting relief under Regs. Sec. 301.9100-1. Therefore, the prudent taxpayer should refer to the litany of letter rulings issued in this area prior to drafting its reasonable cause statement. Specific attention should be paid to the letter rulings previously issued under Sec. 1362(b)(5). The Service has generally accepted reliance on a professional adviser as reasonable cause; however, it has often requested that the adviser acknowledge such reliance and his failure to act in a sworn affidavit. By doing this, an adviser may be opening himself up to a potential malpractice claim. Therefore, an adviser is cautioned not to rely too heavily on the implied "automatic relief" of Rev. Proc. 97-40, because it still requires the taxpayer to establish reasonable cause for failure to timely file. Rev. Proc. 97-40 should be viewed merely as a simplified alternative to the formal letter ruling procedure.