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April 11, 2023 at 02:06 PM
What You Need to Know
- Issuance of the IRS Revenue Procedure 2022-19 offers S corporations a pathway to retroactively correct certain errors in the issuance of stock.
- Such errors jeopardize favorable tax mitigation opportunities enjoyed by small-business owners and their partners.
- The American Institute of CPAs says the important revenue procedure can be enhanced in three key ways.
A prominent member association representing the U.S. accounting profession is calling on the Internal Revenue Service to clarify and expand a revenue procedure issued last year that impacts the operation and tax reporting of S corporations.
Put simply, Revenue Procedure 2022-19 created new taxpayer assistance procedures that allow S corporations and their shareholders to resolve frequently encountered issues surrounding the issuance of equity shares with greater certainty — and without requesting a private letter ruling from the IRS.
As pointed out in an open letter sent to the IRS by the American Institute of CPAs, the revenue procedure’s publication in October created a new opportunity for taxpayers to retroactively address situations in which they may discover an inadvertent occurrence of a “non-identical governing provision” that created the potential of an S corporation offering a second class of stock.
While this may seem like an esoteric distinction, it is actually an important factor for S corporations, according to the AICPA. This is because S corporations, which offer favorable tax management and mitigation opportunities for small-business owners and their partners, are only permitted to maintain their taxation status if they offer one type of stock to 100 or fewer members.
Errors in the management of such issues can cause the IRS to revoke an S corporation’s status as such — a potentially disastrous outcome for small-business owners. Thus, the accounting and small-business communities have embraced Revenue Procedure 2022-19, and they are now calling on the IRS to further expand and clarify the retroactive correction procedures.
What the IRS Says
According to a summary and review of the revenue procedure published last year by the accounting firm KPMG, one of the most significant elements of the revenue procedure is the description of certain situations in which taxpayers may “retroactively validate or preserve” an S election that was terminated solely as the result of one or more “non-identical governing provisions.”
The occurrence of such non-identical governing provisions can mean that, for federal income tax purposes, the S corporation effectively has more than one class of stock under key sections of the revenue code. Notably, this can be true even if the S corporation never made a non-pro rata distribution or liquidating distribution.
As spelled out in Revenue Procedure 2022-19, generally, a small-business corporation is now eligible for retroactive corrective relief if a certain set of requirements are met. According to KPMG’s analysis, among these provisions is the requirement that the corporation has not made a “disproportionate distribution” to an applicable shareholder.
KPMG’s analysis suggests disproportionate distributions by a corporation generally do not constitute a second class of stock — so long as the corporation’s governing provisions provide for identical distribution and liquidation rights. However, in order to meet the requirements for relief under the new revenue procedure, presumably all distributions must be identical as to timing and amount, according to KPMG.
Other requirements for relief include that the corporation timely filed a return on Form 1120-S for each taxable year of the corporation, beginning with the taxable year in which the first non-identical governing provision was adopted and through the taxable year immediately preceding the taxable year in which the corporation made a request for corrective.
