TO

FROM: Peter Staron

Date 5/13/2015
Based on the finding Company X will have to change accounting methods to the accrual basis. IRS
Publication 538 states a corporation or partnership has to use the accrual method if the company fails to
meet the Gross Receipts test. The IRS defines the Gross receipts test and explains when the company has
to change methods of accounting as
Gross receipts test. A corporation or partnership, other than a tax shelter, that meets the gross
receipts test can generally use the cash method. A corporation or a partnership meets the test if,
for each prior tax year beginning after 1985, its average annual gross receipts are $5 million or
less.
An entity's average annual gross receipts for a prior tax year are determined by:
1. Adding the gross receipts for that tax year and the 2 preceding tax years; and
2. Dividing the total by 3.
Change to accrual method. A corporation or partnership that fails to meet the gross receipts
test for any tax year is prohibited from using the cash method and must change to an accrual
method of accounting, effective for the tax year in which the entity fails to meet this test.
(Publication 538)
When a company has to change methods in accounting the IRS states that the tax payer has to file Form
3115 Application for Changes in Accounting Method. In form 3115 Application for Changes in
Accounting Method it explains how to perform all the proper allocation and amortization.
Can a LLC, LLP own a S corporation or can the S corporation become a shareholder in a existing s
corporation?
The IRS does not specifically state that a LLC, LLP or another S corporation can become a shareholder in
an existing S corporation. But the IRS states that the S corporations only shareholders are individuals,
estates, exempt organizations described in section 401(a) or 501(c)(3), or certain trusts described in
section 1361(c)(2)(A).(IRS General Instruction Who May Elect and 26 U.S. Code 1361(b)(1)(b)) .
When looking at 26 U.S. Code 501 (c) (3) to see if a LLC or LLP would be considered a exempt
organization it states that no part of the net earnings of which inures to the benefit of any private
shareholder or individual. The company becoming a shareholder is there to make a profit so it would not
be an eligible shareholder. The IRS also says that no nonresident alien may be shareholders and the S
corporation can have only one class of stock. 26 U.S. Code 1361(b) (2) (a) states that an ineligible
corporation is a financial institution which uses the reserve method of accounting for bad debts described
in section 585. A venture capital firm may be considered a financial institution in this case. There have
only been a few cases where a LLC or a LLP could own shares in a S corporation and they are in PLR
200816002-200816004. But, in all the cases they have been a single-member LLC. Stating this and airing

on the side of caution it could be concluded that when the LLC, LLP, or S Corporation becomes a
shareholder of a existing S corporation this would terminate the corporations S election.