
From the U.S. Code Online via GPO Access
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[Laws in effect as of January 2, 2001]
[Document not affected by Public Laws enacted between
  January 2, 2001 and January 28, 2002]
[CITE: 26USC1362]

 
                     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
 
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.

(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) 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 to obtain 
        shareholder consents, or
            (B) was terminated under paragraph (2) or (3) of subsection 
        (d),

        (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 is a small business corporation, 
        or
            (B) to acquire the required shareholder consents, and

        (4) the corporation, and each person who was a shareholder in 
    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 circumstances resulting in such 
ineffectiveness or termination, such corporation shall be treated as an 
S corporation 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.

(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, Secs. 1006(f)(6), 1007(g)(9), Nov. 10, 1988, 102 Stat. 
3406, 3435; Pub. L. 104-188, title I, Secs. 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.)


                               Amendments

    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 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.''

                  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.
