Internal Revenue Code:Sec. 1362. Election; revocation; termination
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Location in Internal Revenue Code
TITLE 26 - INTERNAL REVENUE CODE
Subtitle A - Income Taxes
CHAPTER 1 - NORMAL TAXES AND SURTAXES
Subchapter S - Tax Treatment of S Corporations and Their
Shareholders
PART I - IN GENERAL
Statute
Sec. 1362. Election; revocation; termination
(a) Election
(1) In general
Except as provided in subsection (g), a small business
corporation may elect, in accordance with the provisions of this
section, to be an S corporation.
(2) All shareholders must consent to election
An election under this subsection shall be valid only if all
persons who are shareholders in such corporation on the day on
which such election is made consent to such election.
(b) When made
(1) In general
An election under subsection (a) may be made by a small
business corporation for any taxable year -
(A) at any time during the preceding taxable year, or
(B) at any time during the taxable year and on or before the
15th day of the 3d month of the taxable year.
(2) Certain elections made during 1st 2 1/2 months treated as
made for next taxable year
If -
(A) an election under subsection (a) is made for any taxable
year during such year and on or before the 15th day of the 3d
month of such year, but
(B) either -
(i) on 1 or more days in such taxable year before the day
on which the election was made the corporation did not meet
the requirements of subsection (b) of section 1361, or
(ii) 1 or more of the persons who held stock in the
corporation during such taxable year and before the election
was made did not consent to the election,
then such election shall be treated as made for the following
taxable year.
(3) Election made after 1st 2 1/2 months treated as made for
following taxable year
If -
(A) a small business corporation makes an election under
subsection (a) for any taxable year, and
(B) such election is made after the 15th day of the 3d month
of the taxable year and on or before the 15th day of the 3rd
month of the following taxable year,
then such election shall be treated as made for the following
taxable year.
(4) Taxable years of 2 1/2 months or less
For purposes of this subsection, an election for a taxable year
made not later than 2 months and 15 days after the first day of
the taxable year shall be treated as timely made during such
year.
(5) Authority to treat late elections, etc., as timely
If -
(A) an election under subsection (a) is made for any taxable
year (determined without regard to paragraph (3)) after the
date prescribed by this subsection for making such election for
such taxable year or no such election is made for any taxable
year, and
(B) the Secretary determines that there was reasonable cause
for the failure to timely make such election,
the Secretary may treat such an election as timely made for such
taxable year (and paragraph (3) shall not apply).
(c) Years for which effective
An election under subsection (a) shall be effective for the
taxable year of the corporation for which it is made and for all
succeeding taxable years of the corporation, until such election is
terminated under subsection (d).
(d) Termination
(1) By revocation
(A) In general
An election under subsection (a) may be terminated by
revocation.
(B) More than one-half of shares must consent to revocation
An election may be revoked only if shareholders holding more
than one-half of the shares of stock of the corporation on the
day on which the revocation is made consent to the revocation.
(C) When effective
Except as provided in subparagraph (D) -
(i) a revocation made during the taxable year and on or
before the 15th day of the 3d month thereof shall be
effective on the 1st day of such taxable year, and
(ii) a revocation made during the taxable year but after
such 15th day shall be effective on the 1st day of the
following taxable year.
(D) Revocation may specify prospective date
If the revocation specifies a date for revocation which is on
or after the day on which the revocation is made, the
revocation shall be effective on and after the date so
specified.
(2) By corporation ceasing to be small business corporation
(A) In general
An election under subsection (a) shall be terminated whenever
(at any time on or after the 1st day of the 1st taxable year
for which the corporation is an S corporation) such corporation
ceases to be a small business corporation.
(B) When effective
Any termination under this paragraph shall be effective on
and after the date of cessation.
(3) Where passive investment income exceeds 25 percent of gross
receipts for 3 consecutive taxable years and corporation has
accumulated earnings and profits
(A) Termination
(i) In general
An election under subsection (a) shall be terminated
whenever the corporation -
(I) has accumulated earnings and profits at the close of
each of 3 consecutive taxable years, and
(II) has gross receipts for each of such taxable years
more than 25 percent of which are passive investment
income.
(ii) When effective
Any termination under this paragraph shall be effective on
and after the first day of the first taxable year beginning
after the third consecutive taxable year referred to in
clause (i).
(iii) Years taken into account
A prior taxable year shall not be taken into account under
clause (i) unless -
(I) such taxable year began after December 31, 1981, and
(II) the corporation was an S corporation for such
taxable year.
(B) Gross receipts from sales of capital assets (other than
stock and securities)
For purposes of this paragraph, in the case of dispositions
of capital assets (other than stock and securities), gross
receipts from such dispositions shall be taken into account
only to the extent of the capital gain net income therefrom.
(C) Passive investment income defined
For purposes of this paragraph -
(i) In general
Except as otherwise provided in this subparagraph, the term
''passive investment income'' means gross receipts derived
from royalties, rents, dividends, interest, annuities, and
sales or exchanges of stock or securities (gross receipts
from such sales or exchanges being taken into account for
purposes of this paragraph only to the extent of gains
therefrom).
(ii) Exception for interest on notes from sales of inventory
The term ''passive investment income'' shall not include
interest on any obligation acquired in the ordinary course of
the corporation's trade or business from its sale of property
described in section 1221(a)(1).
(iii) Treatment of certain lending or finance companies
If the S corporation meets the requirements of section
542(c)(6) for the taxable year, the term ''passive investment
income'' shall not include gross receipts for the taxable
year which are derived directly from the active and regular
conduct of a lending or finance business (as defined in
section 542(d)(1)).
(iv) Treatment of certain liquidations
Gross receipts derived from sales or exchanges of stock or
securities shall not include amounts received by an S
corporation which are treated under section 331 (relating to
corporate liquidations) as payments in exchange for stock
where the S corporation owned more than 50 percent of each
class of stock of the liquidating corporation.
(D) Special rule for options and commodity dealings
(i) In general
In the case of any options dealer or commodities dealer,
passive investment income shall be determined by not taking
into account any gain or loss (in the normal course of the
taxpayer's activity of dealing in or trading section 1256
contracts) from any section 1256 contract or property related
to such a contract.
(ii) Definitions
For purposes of this subparagraph -
(I) Options dealer
The term ''options dealer'' has the meaning given such
term by section 1256(g)(8).
(II) Commodities dealer
The term ''commodities dealer'' means a person who is
actively engaged in trading section 1256 contracts and is
registered with a domestic board of trade which is
designated as a contract market by the Commodities Futures
Trading Commission.
(III) Section 1256 contract
The term ''section 1256 contract'' has the meaning given
to such term by section 1256(b).
(E) Treatment of certain dividends
If an S corporation holds stock in a C corporation meeting
the requirements of section 1504(a)(2), the term ''passive
investment income'' shall not include dividends from such C
corporation to the extent such dividends are attributable to
the earnings and profits of such C corporation derived from the
active conduct of a trade or business.
(F) Exception for banks; etc.--In the case of a bank (as defined
in section 581), a depository institution holding company (as defined
in section 3(w)(1) of the Federal Deposit Insurance Act (12 U.S.C.
1813(w)(1)), the term `passive investment income' shall not include--
(i) interest income earned by such bank or
company, or
(ii) dividends on assets required to be held
by such bank or company, including stock in the
Federal Reserve Bank, the Federal Home Loan Bank,
or the Federal Agricultural Mortgage Bank or
participation certificates issued by a Federal
Intermediate Credit Bank.
(e) Treatment of S termination year
(1) In general
In the case of an S termination year, for purposes of this
title -
(A) S short year
The portion of such year ending before the 1st day for which
the termination is effective shall be treated as a short
taxable year for which the corporation is an S corporation.
(B) C short year
The portion of such year beginning on such 1st day shall be
treated as a short taxable year for which the corporation is a
C corporation.
(2) Pro rata allocation
Except as provided in paragraph (3) and subparagraphs (C) and
(D) of paragraph (6), the determination of which items are to be
taken into account for each of the short taxable years referred
to in paragraph (1) shall be made -
(A) first by determining for the S termination year -
(i) the amount of each of the items of income, loss,
deduction, or credit described in section 1366(a)(1)(A), and
(ii) the amount of the nonseparately computed income or
loss, and
(B) then by assigning an equal portion of each amount
determined under subparagraph (A) to each day of the S
termination year.
(3) Election to have items assigned to each short taxable year
under normal tax accounting rules
(A) In general
A corporation may elect to have paragraph (2) not apply.
(B) Shareholders must consent to election
An election under this subsection shall be valid only if all
persons who are shareholders in the corporation at any time
during the S short year and all persons who are shareholders in
the corporation on the first day of the C short year consent to
such election.
(4) S termination year
For purposes of this subsection, the term ''S termination
year'' means any taxable year of a corporation (determined
without regard to this subsection) in which a termination of an
election made under subsection (a) takes effect (other than on
the 1st day thereof).
(5) Tax for C short year determined on annualized basis
(A) In general
The taxable income for the short year described in
subparagraph (B) of paragraph (1) shall be placed on an annual
basis by multiplying the taxable income for such short year by
the number of days in the S termination year and by dividing
the result by the number of days in the short year. The tax
shall be the same part of the tax computed on the annual basis
as the number of days in such short year is of the number of
days in the S termination year.
(B) Section 443(d)(2) to apply
Subsection (d) of section 443 shall apply to the short
taxable year described in subparagraph (B) of paragraph (1).
(6) Other special rules
For purposes of this title -
(A) Short years treated as 1 year for carryover purposes
The short taxable year described in subparagraph (A) of
paragraph (1) shall not be taken into account for purposes of
determining the number of taxable years to which any item may
be carried back or carried forward by the corporation.
(B) Due date for S year
The due date for filing the return for the short taxable year
described in subparagraph (A) of paragraph (1) shall be the
same as the due date for filing the return for the short
taxable year described in subparagraph (B) of paragraph (1)
(including extensions thereof).
(C) Paragraph (2) not to apply to items resulting from section
338
Paragraph (2) shall not apply with respect to any item
resulting from the application of section 338.
(D) Pro rata allocation for S termination year not to apply if
50-percent change in ownership
Paragraph (2) shall not apply to an S termination year if
there is a sale or exchange of 50 percent or more of the stock
in such corporation during such year.
(f) Inadvertent invalid elections or terminations
If -
(1) an election under subsection (a), section 1361(b)(3)(B)
(ii), or section 1361(c)(1)(A) (ii)by any corporation -
(A) was not effective for the taxable year for which made
(determined without regard to subsection (b)(2)) by reason of a
failure to meet the requirements of section 1361(b) or
obtain shareholder consents, or
(B) was terminated under paragraph (2) or (3) of subsection
(d), section 1361(b)(3)(C),or section 1361(c)(1)(D)(iii),
(2) the Secretary determines that the circumstances resulting
in such ineffectiveness or termination were inadvertent,
(3) no later than a reasonable period of time after discovery
of the circumstances resulting in such ineffectiveness or
termination, steps were taken -
(A) so that the corporation for which the election
was made or the termination occurred is a small business
corporation or a qualified subchapter S subsidiary, as
the case may be, or
(B) to acquire the required shareholder consents, and
(4) the corporation for which the election was made or the
termination occurred, and each person who was a shareholder in
such corporation at any time during the period specified
pursuant to this subsection, agrees to make such adjustments
(consistent with the treatment of such corporation as an S
corporation or a qualified subchapter S subsidiary, as the case
may be) as may be required by the Secretary with respect to
such period,
then, notwithstanding the circumstances resulting in such
ineffectiveness or termination, such corporation shall be
treated as an S Corporation or a qualified subchapter S subsidary,
as the case may be during the period specified by the
Secretary. .
(g) Election after termination
If a small business corporation has made an election under
subsection (a) and if such election has been terminated under
subsection (d), such corporation (and any successor corporation)
shall not be eligible to make an election under subsection (a) for
any taxable year before its 5th taxable year which begins after the
1st taxable year for which such termination is effective, unless
the Secretary consents to such election.
Sources
(Added Pub. L. 97-354, Sec. 2, Oct. 19, 1982, 96 Stat. 1672;
amended Pub. L. 98-369, div. A, title I, Sec. 102(d)(2), title
VII, Sec. 721(g), (h), (l), (t), July 18, 1984, 98 Stat. 623, 968,
969, 971; Pub. L. 100-647, title I, Sec. 1006(f)(6), 1007(g)(9),
Nov. 10, 1988, 102 Stat. 3406, 3435; Pub. L. 104-188, title I, Sec.
1305(a), (b), 1308(c), 1311(b)(1), Aug. 20, 1996, 110 Stat. 1779,
1780, 1783, 1784; Pub. L. 106-170, title V, Sec. 532(c)(2)(T), Dec.
17, 1999, 113 Stat. 1931.)
Miscellaneous
AMENDMENTS
2004 - Subsec.238(a)(1) through (5),Pub.L.108-357, amended
Sec.1362(f) effective for elections and terminations made
after December 31, 2004.
2004 - Subsec.237(a),Pub.L.108-357, amended Sec.1362(d)
(3) by adding a new subparagraph (F). Effective Date.--The
amendment made by this section shall apply to taxable years
beginning after December 31, 2004.
2004 - Subsec.231(b)(2),Pub.L.108-357, amended Sec.1362(f)
paragraph (1)(B)by inserting ``or section 1361(c)(1)(D)(iii)''
after ``section 1361(b)(3)(C),''. Effective for elections and
terminations made after December 31, 2004.
2004 - Subsec.231(b)(1),Pub.L.108-357, amended Sec.1362(f)
paragraph (1) by inserting ``or section 1361(c)(1)(A)(ii)'' after
``section 1361(b)(3)(B)(ii),''. Effective for terminations and
elections made after December 31, 2004.
1999 - Subsec. (d)(3)(C)(ii). Pub. L. 106-170 substituted
''section 1221(a)(1)'' for ''section 1221(1)''.
1996 - Subsec. (b)(5). Pub. L. 104-188, Sec. 1305(b), added par.
(5).
Subsec. (d)(3). Pub. L. 104-188, Sec. 1311(b)(1)(A), in heading
substituted ''accumulated'' for ''subchapter C''.
Subsec. (d)(3)(A)(i)(I). Pub. L. 104-188, Sec. 1311(b)(1)(B),
substituted ''accumulated'' for ''subchapter C''.
Subsec. (d)(3)(B) to (E). Pub. L. 104-188, Sec. 1311(b)(1)(C),
redesignated subpars. (C) to (F) as (B) to (E), respectively, and
struck out former subpar. (B) which read as follows:
''(B) Subchapter c earnings and profits. - For purposes of
subparagraph (A), the term 'subchapter C earnings and profits'
means earnings and profits of any corporation for any taxable year
with respect to which an election under section 1362(a) (or under
section 1372 of prior law) was not in effect.''
Subsec. (d)(3)(F). Pub. L. 104-188, Sec. 1311(b)(1)(C),
redesignated subpar. (F) as (E).
Pub. L. 104-188, Sec. 1308(c), added subpar. (F).
Subsec. (f). Pub. L. 104-188, Sec. 1305(a), amended subsec. (f)
generally. Prior to amendment, subsec. (f) read as follows:
''(f) Inadvertent Terminations. - If -
''(1) an election under subsection (a) by any corporation was
terminated under paragraph (2) or (3) of subsection (d),
''(2) the Secretary determines that the termination was
inadvertent,
''(3) no later than a reasonable period of time after discovery
of the event resulting in such termination, steps were taken so
that the corporation is once more a small business corporation,
and
''(4) the corporation, and each person who was a shareholder of
the corporation at any time during the period specified pursuant
to this subsection, agrees to make such adjustments (consistent
with the treatment of the corporation as an S corporation) as may
be required by the Secretary with respect to such period,
then, notwithstanding the terminating event, such corporation shall
be treated as continuing to be an S corporation during the period
specified by the Secretary.''
1988 - Subsec. (d)(3)(D)(v). Pub. L. 100-647, Sec. 1006(f)(6)(A),
struck out cl. (v) which related to special rule for options and
commodities dealers.
Subsec. (d)(3)(E). Pub. L. 100-647, Sec. 1006(f)(6)(B), added
subpar. (E).
Subsec. (e)(5)(B). Pub. L. 100-647, Sec. 1007(g)(9), substituted
''Subsection (d)'' for ''Subsection (d)(2)''.
1984 - Subsec. (b)(3)(B). Pub. L. 98-369, Sec. 721(l)(2),
substituted ''on or before the 15th day of the 3rd month of the
following taxable year'' for ''on or before the last day of such
taxable year''.
Subsec. (b)(4). Pub. L. 98-369, Sec. 721(l)(1), added par. (4).
Subsec. (d)(3)(D)(v). Pub. L. 98-369, Sec. 102(d)(2), added cl.
(v).
Subsec. (e)(2). Pub. L. 98-369, Sec. 721(g)(2), substituted ''as
provided in paragraph (3) and subparagraphs (C) and (D) of
paragraph (6)'' for ''as provided in paragraph (3)''.
Subsec. (e)(3)(B). Pub. L. 98-369, Sec. 721(h), struck out
''All'' in heading, and substituted ''subsection'' for
''paragraph'' and ''S short year and all persons who are
shareholders in the corporation on the first day of the C short
year'' for ''S termination year'' in text.
Subsec. (e)(6)(C). Pub. L. 98-369, Sec. 721(g)(1), added subpar.
(C).
Subsec. (e)(6)(D). Pub. L. 98-369, Sec. 721(t), added subpar.
(D).
EFFECTIVE DATE OF 2004 AMENDMENT
Amendment by Pub.L.108-357,Sec.237(a) shall apply to
taxable years beginning after December 31, 2004.
Subsec.231(b)(2),Pub.L.108-357; Effective for elections and
terminations made after December 31, 2004. Subsec.231(b)
(1),Pub.L.108-357; Effective for terminations and
elections made after December 31, 2004. Amendments made
by Sec.238(a),Pub.L.108-357, shall apply to elections
made and terminations made after December 31, 2004.
EFFECTIVE DATE OF 1999 AMENDMENT
Amendment by Pub. L. 106-170 applicable to any instrument held,
acquired, or entered into, any transaction entered into, and
supplies held or acquired on or after Dec. 17, 1999, see section
532(d) of Pub. L. 106-170, set out as a note under section 170 of
this title.
EFFECTIVE DATE OF 1996 AMENDMENT
Section 1305(c) of Pub. L. 104-188 provided that: ''The
amendments made by subsections (a) and (b) (amending this section)
shall apply with respect to elections for taxable years beginning
after December 31, 1982.''
Amendment by sections 1308(c) and 1311(b)(1) of Pub. L. 104-188
applicable to taxable years beginning after Dec. 31, 1996, see
section 1317(a) of Pub. L. 104-188, set out as a note under section
641 of this title.
EFFECTIVE DATE OF 1988 AMENDMENT
Amendment by Pub. L. 100-647 effective, except as otherwise
provided, as if included in the provision of the Tax Reform Act of
1986, Pub. L. 99-514, to which such amendment relates, see section
1019(a) of Pub. L. 100-647, set out as a note under section 1 of
this title.
EFFECTIVE DATE OF 1984 AMENDMENT
Amendment by section 102(d)(2) of Pub. L. 98-369 applicable to
positions established after July 18, 1984, in taxable years ending
after that date except as otherwise provided, see section 102(f),
(g) of Pub. L. 98-369, set out as a note under section 1256 of this
title.
Amendment by section 721(g), (h), (l), (t) of Pub. L. 98-369
effective as if included in the Subchapter S Revision Act of 1982,
Pub. L. 97-354, except that amendment by section 721(g)(1) is not
applicable to certain qualified stock purchases, amendment by
section 721(l) is applicable to any election under this section (or
any corresponding provision of prior law) made after Oct. 19, 1982,
and amendment by section 721(t) is not applicable to certain S
termination years, see section 721(y) of Pub. L. 98-369, set out as
a note under section 1361 of this title.
EFFECTIVE DATE
Section applicable to taxable years beginning after Dec. 31,
1982, except that in the case of a taxable year beginning during
1982, subsec. (d)(3) of this section and sections 1366(f)(3) and
1375 of this title shall apply, and section 1372(e)(5) of this
title as in effect on the day before Oct. 19, 1982, shall not
apply, see section 6(a), (b)(3) of Pub. L. 97-354, set out as a
note under section 1361 of this title. For additional provisions
relating to the treatment of certain elections under prior law for
purposes of subsec. (g) of this section, see section 6(e) of Pub.
L. 97-354, set out as a note under section 1361 of this title.
TREATMENT OF CERTAIN ELECTIONS UNDER PRIOR LAW
Section 1317(b) of Pub. L. 104-188 provided that: ''For purposes
of section 1362(g) of the Internal Revenue Code of 1986 (relating
to election after termination), any termination under section
1362(d) of such Code in a taxable year beginning before January 1,
1997, shall not be taken into account.''
SUBCHAPTER S ELECTION
Section 102(d)(3) of Pub. L. 98-369, as amended by Pub. L.
99-514, Sec. 2, title XVIII, Sec. 1808(a)(2), Oct. 22, 1986, 100
Stat. 2095, 2817, provided that: ''If a commodities dealer or an
options dealer -
''(A) becomes a small business corporation (as defined in
section 1361(b) of the Internal Revenue Code of 1986 (formerly
I.R.C. 1954)) at any time before the close of the 75th day after
the date of the enactment of this Act (July 18, 1984), and
''(B) makes the election under section 1362(a) of such Code
before the close of such 75th day,
then such dealer shall be treated as having received approval for
and adopted a taxable year beginning on the first day during 1984
on which it was a small business corporation (as so defined) or
such other day as may be permitted under regulations and ending on
the date determined under section 1378 of such Code and such
election shall be effective for such taxable year.''
References
SECTION REFERRED TO IN OTHER SECTIONS
This section is referred to in sections 943, 1042, 1361, 1363,
1371, 1374, 1375, 1377, 1379, 6103 of this title.
