The Firm's article, "Incentives for Emerging Growth Companies to Revoke S Election", is forthcoming in next week's issue of Bloomberg Tax Management Memorandum. The article zeroes in on the fast-approaching deadline for revoking S corporation status by EGCs in the process of seeking additional series of private equity financing. Generally, an S corporation provides for pass-through taxation of shareholders, whereas a C corporation is subject to two tiers of income tax at the corporate and indivual levels. However, taking into account certain changes to federal income tax laws under the Tax Cuts and Jobs Act of 2017, Pub. L. 115-97, 131 Stat. 2054 ("TCJA"), EGCs organized as small business corporations under subchapter S of the Internal Revenue Code of 1986, as amended (the "Code") may prefer tax benefits available to business entities in C corporation form.
The due date for revoking the S election to take advantage of certain tax-free qualified cash distributions by a former S corporation to current and subsequent shareholders is December 21, 2019. Thus, S corporations that have been considering the tax benefits of an eligible terminated S corporation ("ETSC") during the extended post-termination transition period ("PTTP") under Code sections 481(d) and 1371(f) enacted under TCJA section 13543, have limited time to act. Absent further IRS guidance, and subject to any applicable tax avoidance or anti-abuse provisions under the Code, an S corporation may be able to rescind the revocation of an S election. Rescission may reverse he potential impact of a revocation in the event circumstances change for S corporation stakeholders.
EGCs that revoke the S election by December 21, 2019 may select any future effective date of the revocation, thus allowing time to negotiate and close any contemplated financing rounds or increase the accumulated adjustments account ("AAA"), a tax account of an S corporation within the meaning of Code section 1368(e), which would be the source of tax-free ETSC distributions. Current S corporation shareholders and future equity investors or transferees of ETSC stock after the revocation date may receive qualified distributions under proposed regulations published by Treasury and the IRS, REG-131071-18 (Nov. 4, 2019). Corporations which revoked the S election during the statutory two-year period ending December 21, 2019 or S corporations contemplating conversion to subchapter C before the due date should consult with counsel regardng requirements and effects of an S election revocation.