The IRS Issues New Procedures Affecting S Corporations

On October 10, 2022, the IRS issued a new revenue procedure allowing S corporations and their shareholders to resolve certain issues without having to request a private letter ruling (PLR).

What is a Private Letter Ruling (PLR)?
A private letter ruling (PLR) is issued by the IRS to a taxpayer in response to a written request for guidance about an unusual or complicated situation. It cannot be relied on as precedent, but it is considered binding as long as the taxpayer has fully and accurately described the situation.

The filing fee for a PLR ranges from $275 to $38,000, so the new procedures could represent significant savings for some businesses.

What is an S Corporation (S Corp)?
S corporations are a type of legal business structure with specific liability and tax advantages. They get their name from IRS Subchapter S, which regulates how they’re taxed. Like LLCs, S corporations confer limited liability on owners and shareholders and, again like LLCs, offer “pass-through” taxation, meaning that shareholders are taxed on income from the business, but the corporation itself is not taxed.

Unlike LLCs, however, S corps are subject to more stringent IRS rules about the number and type of members.

What is a Qualified Subchapter S Subsidiary (QSub or QSSS)?
With some exceptions, an S Corp cannot own another S Corp unless one is a qualified subchapter S subsidiary, also known as a QSub or QSSS. Without the QSub election, the child company becomes a regular C Corporation.

To be eligible for QSub election, a subsidiary must be a domestic corporation whose stock is owned 100% by an S corporation. If a parent company sells even one share of the child, the child company will lose its QSub status. Likewise, the child company must follow the legal requirements of an S corp or risk losing its status.

The parent can make an election to treat the subsidiary as a QSub at any time during the tax year, but typically, the effective date cannot be more than 12 months after the date the election is filed or 2 months and 15 days before it is filed.

Advantages of a QSub
Electing a QSub isolates the liabilities of each corporation from each other, so that the parent company cannot be sued or held financially responsible if the QSub runs into legal or financial issues.

However, for state and federal tax purposes, all assets, liabilities, expenses, items of income, deductions, and credits of the subsidiary are treated as belonging to the parent corporation. As an S Corp, the parent company pay does not pay corporate income taxes on either its own profits or the profits of the QSub company. All profits are passed on to the shareholders, who pay personal income tax on their dividends.

What Does the IRS Ruling Mean?
Formerly, S corporations and their shareholders were often forced to turn to PLRs to resolve specific issues, a process which generally takes 60–90 days, sometimes longer. The following areas [Sections 2.03(1) through 2.03(6)] are now deemed resolvable without a PLR:
• Agreements and arrangements with no principal purpose to circumvent one class of stock Requirement.
• Governing Provisions That Provide for Identical Distribution and Liquidation Rights
• Procedures for Addressing Missing Shareholder Consents, Errors with Regard to a Permitted Year, Missing Officer’s Signature, and Other Inadvertent Errors and Omissions
• Procedures for Verifying S Elections or QSub Elections
• Procedures for Addressing a Federal Income Tax Return Filing Inconsistent with an S Election or a QSub Election
• Procedures for Retroactively Correcting One or More Non-Identical Governing Provisions

Do the New Procedures Affect You?
If you are the owner or a shareholder of an S corporation and have already submitted a request for a PLR, you have a limited time to either rely on this new procedure and withdraw the pending PLR request and get a refund or continue to pursue the pending PLR request.

Even without the need for a PLR, some of the affected procedures and provisions are complex. If you expect them to apply to your business now or in the future, we urge you to speak to one of our qualified tax specialists to understand your rights, obligations, and options.