United States

IRS addresses treatment of redemption payment by terminated S corp

Taxpayers waiting for guidance on distributions by former S corps

TAX ALERT  | 

The IRS has clarified in Revenue Ruling 2019-13 that, in certain circumstances, terminated S corporations should treat redemption payments as tax-free distributions of prior S corporation earnings, and not as payments in exchange for stock.

The ruling addresses the unique situation where a terminated S corporation redeems shares during the post-termination transition period (“PTTP”). The PTTP usually runs for one year starting on the date the S corporation’s pass-through status terminates. Distributions of cash during that one-year period are generally tax free to the extent of any previously undistributed S corporation earnings. Revenue Ruling 2019-13 addressed the situation where the cash payments are in exchange for stock (i.e., redemption payments), yet are treated as distributions under normal tax rules.

Unsurprisingly, the ruling confirms that the “distribution” treatment applies during the PTTP just as it would if the company’s subchapter S status had not terminated. Therefore, the distributions are treated as coming first from undistributed S corporation earnings, and would be tax-free to the extent of the shareholder’s tax basis.

This ruling addresses one of two issues that are listed on Treasury’s Priority Guidance Plan that directly affect terminated S corporations. The other issue relates to clarifying how certain corporations that revoked their subchapter S status within two years of enactment of the Tax Cuts and Jobs Act (“TCJA”) should allocate distributions following the PTTP between the company’s earnings and profits (i.e., its C corporation earnings) and its undistributed S corporation earnings. That guidance is of particular interest to former S corporations that have recently revoked their subchapter S elections in order to take advantage of reduced C corporation tax rates. Many remain optimistic that this guidance may be released by June 22, which is the last date on which regulatory guidance could be retroactively effective.

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