April 07, 2025

As more LLCs elect to be taxed as S corporations, it is increasingly common for legacy provisions in LLC operating agreements to unintentionally jeopardize the validity of such elections. This risk is particularly high when a multi-member LLC—originally taxed as a partnership—elects S corporation status but fails to amend its operating agreement to remove provisions rooted in Subchapter K (the partnership tax rules). A typical example is a clause requiring liquidation according to the members' positive capital account balances. While such a provision is perfectly acceptable in the partnerhsip context, that same provision may result in the existence of a second class of stock that is inconsistent with S corporation requirements.

In many cases, by the time these discrepancies are discovered, the LLC has already been (or always was) disqualified from maintaining its S corporation status. These mistakes are generally inadvertent and often go unnoticed until it’s too late. Recognizing the need for a fair and efficient remedy, the IRS introduced a pathway for S corporations to address and resolve these issues without facing harsh penalties.

Revenue Procedure 2022-19

The IRS has identified five common issues that frequently arise but do not automatically invalidate your S election or your status as a Qualified Subchapter S Subsidiary (QSub). The new guidance makes it easier and faster to resolve these problems.

Five Issues That Do Not Invalidate S Corporation or QSub Elections:

1. Agreements or Clauses that Might Appear to Violate S Corporation Rules. Common arrangements like buy-sell agreements or redemption clauses often appear to conflict with S corporation requirements. The IRS now says that if these arragnements weren’t designed circumvent the S corporation rules, then they won't be treated as violations. Under this guidance, taxpayers may rely on their own assessments of compliance and are no longer required to request a PLR for these situations.

2. Disproportionate Distributions. Even if your S corporation has made disproportionate distributions, so long as the company's governing documents provide for identical distribution and liquidation rights, the presence of disproportionate distributions will not be considered a second class of stock.

3. Errors and Omissions on Forms 2553 and 8869. Errors such as missing shareholder consents, incorrect tax year entries, or unsigned forms can now be corrected using existing relief procedures, including those found in Revenue Procedure 2013-30 and Section 1362(f) of the Internal Revenue Code. In some cases, a written explanation submitted to the IRS will be sufficient, further minimizing the need for PLRs.

4. Missing IRS Acknowledgement Letters. Taxpayers can easily request a replacement S election or QSub Election by calling the IRS Business and Specialty Tax Line at 800-829-4933 or the Practitioner Priority Service at 866-860-4259.

5. Inconsistent Tax Filings. When a corporation has filed federal returns inconsistent with its claimed S or QSub election, it must file corrected returns for all open tax years. The IRS will treat the election as valid during those years, eliminating the need for a PLR in these instances

Retroactive Relief for Non-Identical Governing Provisions

The IRS provides retroactive relief under Section 1362(f) for cases where an S election became invalid or was terminated due to non-identical governing provisions. According to Treasury Regulation §1.1361-1(l)(2)(i), such provisions are problematic if they grant unequal rights to distributions or liquidation proceeds, effectively creating a second class of stock.

To qualify for relief, the following conditions must be met:

• The governing provisions included a clause allowing for non-identical distributions, but no disproportionate distributions were actually made.
• The corporation filed Form 1120-S for each affected tax year.
• Corrective actions were taken by both the corporation and its shareholders before the IRS discovered the issue.

Procedural Steps for Relief

• Documentation: A corporate officer must prepare a signed statement detailing the non-identical provision and the corrective steps taken.
• Shareholder Consent: Each shareholder who held stock during the affected period must sign a consent statement.
• Record Retention: All documentation should be retained in the corporation’s records. Submission to the IRS is not required unless specifically requested.

Conclusion

Revenue Procedure 2022-19 offers S corporations and their shareholders a practical and efficient way to fix common problems that might otherwise invalidate their S election. However, the procedure also shifts responsibility to taxpayers, who must now ensure compliance without relying on IRS confirmation through PLRs. While this increases flexibility, it can introduce uncertainty—especially in transactional contexts where official IRS validation was previously standard. Nonetheless, by carefully following the steps outlined in the revenue procedure, S corporations can preserve their tax status and correct issues that would once have been far more difficult and costly to resolve