October 11, 2022, the Treasury Department issued Revenue Procedure 2022-19 which allows certain governing documents to be corrected and effective retroactively, without the need of a private letter ruling to prevent jeopardizing an S election. It is not clear what the intentions are of the IRS by doing this, but we would strongly advise a review to make sure you are compliant in this area in case of audit.

Background

Often, LLC agreements are initially drafted with partnership taxation boiler plate tax provisions as the default classification, but then later an S election is made for tax purposes. If your operating agreement has any language that generally pertains to partnership taxation, this could be considered non-identical governing provisions and put your S election in jeopardy. If the S election was filed with form 2553, then the entity could revert to a partnership and if it was filed with form 8832 and then form 2553, the result could be taxed as a C corporation, both with potentially negative tax consequences. The following are examples, not all inclusive, of items that an S corporation should not have in their governing documents:

• Allocating income and deductions not in proportion to the ownership interest
• Language that would make it appear that there is more than one class of stock
• Allowing distributions and liquidation proceeds to be based on something other than the stock ownership
• References to distributions for positive balances in their capital accounts or “waterfall” distributions provisions

Corrective action

You should consult with your attorney to review and amend any agreements that do not comply with the S election. Under the Revenue Procedure, an S corporation is eligible for retroactive corrective relief if all of the following requirements are met:

1. As an S corporation, the entity has not made, and for income tax purposes is not deemed to have made, a disproportionate distribution to an applicable shareholder
2. Timely filed the form 1120S for each year
3. Before the IRS discovers the non-identical governing provisions, the following corrective relief statements are completed (Appendix A and B of the Revenue Procedures 2022-19 included examples of both statements):

• The S corporation completes a Corporate Governing Provision Statement in accordance with section 3.06 (2)(c)(ii) of this revenue procedure AND

• All applicable shareholders sign a Shareholder Statement in accordance with section 3.06(2)(c)(iii) of this revenue procedure