Selecting the proper due date for filing an S election.

Facts

Zarco is a newly formed corporation that intends to elect S status. The corporation was formed and began doing business on Jan. 5, 1991. The management has been busy with the corporation's startup and only recently contacted its tax adviser. It met on Mar. 18, 1991 and the S election was signed and postmarked on Mar. 19, 1991.

Issue

Has Zarco made a timely S election for the current year?

Analysis

To be currently effective, an S election must be made --during the preceding year, or --on or before the fifteenth day of the third month of the present year.

Following Prop. Regs. Sec. 1.1362-1(c), the election must occur on or before the date when two months and 15 days have elapsed from the beginning of a new corporation's first tax year, rather than literally the fifteenth day of the third month. Under this interpretation, Zarco's S election for its first year must be filed after Jan. 4, 1991 and before Mar. 20, 1991.

With a newly formed corporation, a practitioner faces two potential restrictions. Filing the S election before corporate formation: An S election is not valid if the corporation does not exist when the election is filed. Under Prop. Regs. Sec. 1.1362-1(e), Example (1), an election made earlier than the beginning of the first tax year will not be valid.

Prop. Regs. Sec. 1.1362-1(c)(3) states that the time for making the S election for a newly formed corporation begins on the date the corporation has shareholders, acquires assets or begins doing business, whichever occurs first. In Rev. Rul. 72-257, the IRS looked to the law of the state in which the incorporation had occurred to determine the start of corporate legal existence.

Since laws many vary from state to state, an S election should not be filed before the corporation has achieved legal existence under state law. This is true not only with a new business venture but also with the incorporation of an existing proprietorship or partnership. The S election for such entities should not be filed before the incorporation date; an existing C corporation, however, may file its S election up to a year in advance of its conversion. Measuring the 2 1/2-month election period: For a newly formed corporation, it may be difficult to determine its proper origination date. Prop. Regs. Sec. 1.1362-1 (c)(3) indicates that the S election period begins at the earliest date that the corporation has shareholders, acquires assets or begins conducting business. Such date is considered the first day of a new corporation's initial tax year. (Reference to the earliest of these three events also appears on IRS Form 2553, Election by a Small Business Corporation.)

Practitioners generally will find that the earliest of these three dates is triggered by the legal incorporation process (the filing or registration date of the articles of incorporation). At this point, even though the shares of stock may not actually have been issued, the corporation may be deemed to have shareholders.

To the extent that any business was conducted prior to the point of incorporation, an S election should not be made. Instead, a tax adviser should file a proprietorship or partnership return to report any business activity up to that point.

There may be circumstances under which a corporation is formed but no immediate activity takes place. For example, an attorney may create a corporation for a client, possibly listing the attorney as incorporator. When the client is ready to proceed, shares will be issued, assets acquired, etc., at which point the measuring of the 2 1/2-month election period begins.

Conclusion

The March 19 S election by Zarco would be timely filed. Under the proposed regulations, the corporation may measure two months and 15 days from the first day of its first tax year.

Zarco's tax adviser must consider the problem of filing the S election too early (i.e., before the corporation has legal existence). Similarly, identification of the event that starts the 2 1/2-month election period (i.e., the earliest of having shareholders, acquiring assets or conducting business) requires careful attention.