REIT Asset and Income Tests for Newly Created Entities

Transcription

1 REIT Asset and Income Tests for Newly Created Entities by David W. Lee, CPA and David L. Brandon, Esq. Washington National Tax * The highly technical real estate investment trust (REIT) qualification tests can present unique challenges for a REIT in its first tax year. Overall, these tests were written with a fully functioning, fully capitalized real estate company in mind, not a freshly minted company that might be dormant during its first year. This article explores some of the issues facing a new REIT and cautions that compliance with the REIT rules should be considered from the beginning. On September 7, 2012, the IRS released a private letter ruling 1 concluding that the inclusion by a REIT of deferred initial public offering (IPO) costs on its balance sheet, which in accordance with the good * David W. Lee is a member of the REIT Services team and a partner in the Passthroughs group of KPMG LLP s Washington National Tax (WNT) office. David Brandon heads the REIT Services team and is a principal in the WNT Passthroughs group; he is also a former general counsel for the National Association of Real Estate Investment Trusts, Inc. and a former assistant branch chief in the IRS Office of Chief Counsel. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 1 PLR Under 6110(k)(3), private letter rulings cannot be used or cited as precedent, but are cited in this article as illustrative of possible analysis by the IRS. faith determination by the REIT s trustees had zero value, would not cause the REIT to fail the 75% asset test. While the ruling itself is not particularly significant (it ultimately concludes that zero equals zero), it nevertheless touches on several questions that must be addressed in the case of new entities intending to elect REIT status. Namely, how does one assure that the REIT asset and income tests are met at the end of a quarter (or tax year) for an entity that is largely dormant, waiting for its U.S. Securities and Exchange Commission (SEC) filing to become effective before completing an initial offering? Use of the REIT platform to invest in U.S. real estate has increased dramatically since its creation in 1960, particularly so in the past 22 years. The market capitalization for publicly traded REITs has grown from approximately the $10 billion to $11 billion range in 1990 to over $450 billion today. Moreover, since the market crash in 2008, REITs have experienced a strong rebound. The period from 2008 to the present included 50% more REIT IPO transactions than in the preceding four years from 2004 to The increased number of IPO transactions was matched with overall higher capital raises as well (including secondary and debt offerings). 2 By all accounts, this increased activity may continue in the foreseeable future. The REIT qualification tests, found in 856 and 857 of the Code, present unique challenges for a REIT in its first tax year. These tests are highly technical and require, among other things, that specific portions of a REIT s assets and income include only designated qualifying assets or income from qualifying real estate sources. Overall, these tests were written with a fully functioning, fully capitalized real estate company in mind. With only a few exceptions, they do not contemplate such real-life variables as managing a new shell entity created for purposes of SEC filings, or managing a significant asset on the 2 National Association of Real Estate Investment Trusts, Inc., Industry Capital Offerings Summary, available at (Aug. 2012) Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 1

2 books that is presently generating no income. With the increase in new REIT offerings in recent years, tax practitioners once again have been forced to wrestle with how to help a newly created, yet largely dormant entity satisfy the myriad REIT qualification rules during its first tax year. ASSET HOLDING REQUIREMENTS Before addressing the specific issues faced by new REITs, it is worthwhile to review the basic REIT asset and income tests. To confirm that the bulk of a RE- IT s investments are in real estate and that the REIT is diversified in any of its other investments, at the end of each quarter of a tax year a REIT must meet each of the following requirements concerning its assets: At least 75% of the value of its total assets must be represented by real estate assets (including shares of another REIT), cash and cash items (including receivables), and U.S. government securities (the 75% asset test). Securities of taxable REIT subsidiaries (TRSs) must not represent more than 25% of the value of the REIT s total assets. Not more than 25% of the value of the REIT s total assets can be represented by securities (other than those qualifying for the 75% asset test). Securities of another issuer held by the REIT (other than securities of TRSs or those qualifying for the 75% asset test) must not represent (1) more than 5% of the value of the REIT s total assets, or (2) more than 10% of the total voting power or the total value of the outstanding securities of such issuer. 3 For purposes of the asset holding requirements, the term total assets means the gross assets of the REIT determined in accordance with generally accepted accounting principles (GAAP). 4 Furthermore, the term value means, with respect to assets (other than securities with readily available market quotations), fair value as determined in good faith by the trustees. 5 For purposes of the 75% asset test, the term real estate assets generally includes real property, interests in mortgages on real property, shares in other 3 856(c)(4). For purposes of the 10% value limitation, certain securities (such as a straight debt and a loan to an individual, an estate, a qualified REIT, or a real estate partnership) are exempt. 4 Regs (d)(3) (c)(5)(A). qualified REITs, and stock or debt instruments attributable to the temporary investment of new capital. The term new capital refers to the proceeds of a stock offering or a public offering of debt securities having maturities of at least five years. 6 To the extent a REIT fails to maintain qualification in any tax year without the benefit of certain savings provisions, it would be subject to tax imposed on a corporation without the deduction for dividends paid. Further, it cannot re-elect to be taxed as a REIT for the four tax years following the year during which it lost qualification. 7 Clearly, no REIT can afford to risk losing its qualified status during the first year of its REIT election. REIT GROSS INCOME TESTS To ensure the bulk of a REIT s income is from passive income sources and not from the active conduct of a trade or business, at least 75% of a REIT s gross income must be derived, inter alia, from rents from real property, mortgage interest, gain on the sale of real property, dividends from shares in other REITs, amounts received in consideration for entering into agreements to make loans on real property, or to lease real property, and certain qualified temporary investment income. Further, a REIT must derive at least 95% of its gross income from items satisfying the 75% test, plus other interest and dividends (i.e., passive income from securities). 8 Over several decades, the IRS issued both public and private rulings carving out several categories of gross income that should not be subject to the literal application of the gross income requirements. These included exceptions for certain self-charged amounts to avoid double-counting the same gross income sources, 9 expense reimbursements and cost-sharing arrangements, 10 legal recoveries, and business income related to the REIT s primary business. 11 In 2008, 856(c)(5)(J) was enacted, which grants the IRS explicit authority either to exclude nonqualifying amounts from the REIT gross income tests or to treat otherwise non-qualifying income as qualifying income, provided this authority is exercised in a manner that is consistent with the purposes of the REIT provisions. 12 It is fair to assume that the IRS will be most inclined to apply 856(c)(5)(J) in situa (c)(5)(B) and (D) (g)(3) (c)(2) and (3). 9 E.g., PLR ; PLR E.g., Rev. Rul ; PLR ; PLR ; PLR E.g., PLR ; PLR American Housing Rescue and Foreclosure Prevention Act Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

3 tions similar to those in which it issued rulings before the statutory change. PLR The facts in PLR indicate that the taxpayer made an IPO of its stock and elected to be taxed as a REIT for However, as of March 31, 2011, its SEC Form 10-Q showed only the following four assets: Highly liquid investments with original maturities of three months or less Deposits and other assets (principally two mortgage application fees related to financings on two real estate acquisitions that closed in April 2011) An amount due from its external advisor for trademark-related legal fees previously paid by the taxpayer on behalf of the advisor Deferred offering costs (nondeductible costs incurred by the taxpayer in connection with its planned IPO of common stock) According to the letter ruling, the deferred offering costs consisted of legal, accounting, and underwriting fees and expenses, printing, mailing, travel, sales, marketing, and similar expenses associated with the IPO. Although the ruling did not disclose the amount of the booked offering costs, presumably it was high enough to cause an asset test qualification problem if it represented the actual value of such deferred costs. The taxpayer represented its trustees acting in good faith determined that the fair value of the IPO offering costs was zero. Based entirely on this representation, the ruling concluded that the inclusion of the taxpayer s deferred offering costs on its GAAP balance sheet would not cause the taxpayer to fail the 75% asset test. On the one hand, the taxpayer s representation that the deferred offering costs had zero value appears reasonable, at least until such time as the SEC filings become effective and completion of the offering is assured. The IRS s acceptance of this value easily resolves the asset test dilemma. On the other hand, one wonders whether such costs would always have zero value. Once the REIT s registration became effective and the IPO transaction was a certainty, is there not some risk that such costs indeed have a significant fair market value? If the end of the quarter passed after this value accrued, but before the REIT acquired significant additional assets (e.g., from the planned offering), its qualified status could be jeopardized. Other assets identified in the ruling present similar problems. The mortgage application fees most likely DORMANT PERIOD Intuitively, an entity that has no assets, income, or business activity generally should be disregarded for tax purposes. In fact, this principle has long been recof 2008, P.L (7/30/08). represent a deferred expense that would be amortized after the mortgage is obtained. Until such time, however, the fees represent a deferred asset on the books, with a real fair market value (assuming the mortgage will be incurred). Since this asset is neither stock nor securities, it does not qualify as property attributable to the temporary investment of new capital and, thus, cannot qualify as a real estate asset on this basis. Likewise, the amount due as reimbursement from the external trademark advisor might not qualify as stock or a debt instrument under the new capital exception. And irrespective of whether such assets qualify as stock or debt instruments, their acquisition is often funded with a privately originated loan not with the proceeds of a stock or public debt offering. Thus, in most cases, the assets that appear on the balance sheet of a newly created entity cannot rely on the temporary investment exception. The facts in this ruling suggest the following questions concern newly organized REITs: Should a REIT that is formed solely to preserve the name and that has no assets or liabilities (or insignificant assets or liabilities) be considered in existence and, thus, required to meet the asset holding requirements since its incorporation? Should a REIT that literally has no assets at the end of a quarter be considered as failing or passing the 75% asset test (i.e., how is the test applied when the denominator is zero)? Should intangible assets that are unavoidable in connection with the creation and establishment of a new REIT, such as the deferred offering costs, be treated as inextricably tied to the REIT s intended business of investing in real estate assets and treated as qualifying real estate assets? Should a REIT that literally has no gross income for its first tax year be considered as failing or passing the 95% and 75% gross income tests (again, how is the test applied when the denominator is zero)? Should the IRS permit reasonable amounts of gross income that may not qualify under either or both of the 75% and 95% gross income tests to be treated as qualifying amounts under 856(c)(5)(J), as long as they are incidental to the organizational process and do not evidence an intent of the REIT to actively pursue non-qualifying sources of income? 2012 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 3

4 ognized, at least for purposes of determining when an entity ceases to exist. Thus, for return filing purposes, the income tax regulations provide: A corporation is not in existence after it ceases business and dissolves, retaining no assets, whether or not under State law it may thereafter be treated as continuing as a corporation for certain limited purposes connected with winding up its affairs, such as for the purpose of suing and being sued. 13 A more recent private ruling appears to follow the same principle when applying the entity classification rules to a newly created entity, when the entity was completely dormant (with no assets, income, deductions, or liabilities) before the relevant date. 14 The theory that the REIT qualification rules should not be applied literally to an essentially dormant entity certainly has appeal. However, to the extent the intended REIT entity is already pursuing its new business, it will likely have certain contractual relationships already in place, such as advisory agreements; purchase and sale agreements; and legal, accounting, and banking agreements. It may also have undertaken filings with the SEC or other governmental agencies. This level of activity makes it difficult to conclude that the entity should be completely disregarded in all cases, even though it may not have any tangible assets or gross income. From a policy standpoint, there is no apparent reason to require such an entity to prove its compliance with the REIT qualification rules; unfortunately, there are no clear legal precedents to support this position. Similar questions arise in connection with an entity that may have booked a nominal amount of qualifying assets, such as cash, in a non-interest-bearing account. Does the fact that the entity has derived zero gross income mean that it need not prove compliance 13 Regs (a)(2). See also Rev. Rul , C.B. 251; Hursloff v. Comr., 46 T.C. 545 (1966), acq C.B PLR In the ruling, X was formed as an LLC under the laws of State on D1. Before D2, X was completely dormant (with no assets, income, deductions, or liabilities). Y merged into X on D2, and X elected to be classified as an association taxable as a corporation, by filing a Form 8832 effective on D2. The IRS ruled that such election was an initial classification election and not a change in classification for purposes of Regs (c)(1)(iv), which generally prohibits an eligible entity from making another election to change its classification within 60 months of an earlier election to change its classification. However, for this purpose, an entity electing out of its default classification effective on the date of formation is not considered to have made a change. This ruling suggests that the IRS has disregarded the period during which X was completely dormant and treated the merger date as the formation date. with the 75% or 95% gross income tests? While one would not expect zero income to equate to failing the tests, there have not been any rulings, much less legal precedents, that answer this question. Fortunately, the IRS has considered a number of situations in which intangible assets were considered related closely enough to real property to justify their classification as real property. The IRS has similarly determined that certain sources of income may be treated as qualifying (or at least ignored under the REIT rules) if closely tied to the REIT s core business purpose of investing in real estate assets. These rulings do not answer the question: How is a REIT with zero assets or income treated? But the rulings should be helpful in other circumstances. Qualifying Asset Classification The types of assets that are most likely to present a REIT qualification problem on a new entity s balance sheet are intangible assets, such as the deferred offering costs described in the letter ruling. The IRS has considered the treatment of various types of goodwill and similar assets and found that they may qualify as real estate assets when they are inextricably tied to a particular piece of real property, or to the REIT s business of investing in real property. Thus, in PLR , a REIT acquired all the stock of a corporation that owned several widely known resort hotels, with significant reputations as travel destinations. For GAAP purposes, the REIT allocated value in excess of replacement costs to goodwill, trade name, brand name, and other intangibles. In connection with the ruling, the REIT represented that: The goodwill portion of the real estate intangibles relates to the location and physical structure of the resort hotels. The value attributable to the hotel name portion of the real estate intangibles relates to the uniqueness in history and heritage that the resort hotels represent to the marketplace. The real estate intangibles were inextricably and compulsorily tied to the real estate portion of the resort hotels. If the REIT s acquisition had been a taxable asset acquisition rather than a stock acquisition, the goodwill and the value ascribed to the hotel names would have been included in the tax basis of the land and buildings for federal income tax purposes, and would not have been separately amortizable. In these circumstances, the IRS concluded that the goodwill and other intangibles were inextricably linked to the underlying properties and would be Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

5 treated as qualifying real estate assets for REIT purposes. In an earlier ruling, PLR , the IRS found that income from the sale of goodwill by a REIT would give rise to qualifying income under the REIT gross income tests. In that fact pattern, the goodwill was attributable in part to the REIT s reputation and operating history and its senior employee group s considerable experience in real estate finance. Also, in PLR , the IRS determined that certain goodwill and other intangibles on a REIT s balance sheet were primarily a function of the GAAP rule requiring that value in excess of replacement costs (of an antenna system) be allocated to intangibles and thus found that these intangibles qualified as real estate assets. The goodwill letter rulings are significant, because Regs (d)(3) states that the total assets of the REIT are the gross assets of the REIT determined in accordance with GAAP. Clearly, GAAP has not identified these intangible assets as real property, so how can these rulings conclude they are real estate assets for purposes of the REIT qualification tests? The IRS evidently concluded, and rightly so, that Regs (d)(3) should not be applied in such a literal fashion as to lead to results that are unavoidable under modern accounting rules and clearly incongruous with the overall intent of the REIT provisions. 15 The IRS similarly limited the literal scope of this regulation in 1996, when it privately ruled that the assets of a qualified REIT subsidiary (a disregarded entity) should be reported on a gross basis by the REIT, even though GAAP apparently permitted reporting only the net value of the subsidiary. 16 The rationale described in the goodwill private letter rulings arguably should result in the intangibles identified in PLR being classified as qualifying real estate assets. Admittedly, the value of deferred offering costs is different from the types of goodwill discussed in the rulings. Nonetheless, the creation of these assets is unavoidable in connection with the process of creating a new REIT. A REIT is required to be operated in a corporate structure, and the structure cannot be created without booking the value of some deferred costs. In this sense, these costs are inextricably linked to the REIT s intended and permitted business activities. Under the private rulings, this should be sufficient to treat them as qualifying assets. 15 The purpose of the REIT provisions is not to impose, or retain, any specified number of taxes with respect to income, but rather to accord individuals of small means an opportunity to pool their investments, yet receive the same treatment as those of greater wealth can obtain by direct investments. H. Rep , p.4 (6/28/60). 16 PLR The argument is even more compelling in the case of the mortgage application fees. These are clearly inextricably linked to the real estate asset for which the mortgage will be incurred. On this basis alone, these fees seemingly should be treated as qualifying assets until they are finally amortized. The receivable from the external advisor for legal fee reimbursement is more questionable. In the first instance, the item is simply a receivable. If it is characterized as a security, it is potentially subject to the securities diversification rules. However, if the debt is not a security and if the underlying fee to which it relates was itself related to the creation of the REIT, then an argument can be advanced that this asset ought to be classified as a qualifying asset, or at least not taken into account for REIT qualification purposes. 17 Other Asset Categories Both newly formed REITs and existing REITs often have to account for various other types of intangibles that may be acquired in connection with the acquisition of real property. Some of these asset categories may not even be recognized as separate assets for federal income tax purposes; in other cases, the assets are so intertwined with the tangible asset that their character ought to be treated the same for REIT purposes. A few examples: Deferred Leasing Costs A REIT that holds real property for rental often has capitalized (or unamortized) leasing commissions reflected on its balance sheet for GAAP purposes. Because these costs are necessary for securing tenants that pay rent, one may reasonably conclude that they have value. Similar to the treatment of unamortized mortgage application fees, these assets are inextricably tied to the property and the tenants leases and should be classified as real estate assets. Prepaid Real Estate Taxes and Property Insurance For purposes of the asset holding requirements, a REIT is not required to revalue its assets at the end of any quarter during which there has been no acquisition of a security or other property because the mere change in market value of property held by the REIT does not, of itself, affect the REIT s status as a REIT. 18 For this purpose, the income tax regulations explain [a] change in the nature of cash item, for example, the prepayment of insurance or taxes, does 17 In PLR , the IRS allowed a REIT to exclude from its asset tests state tax credit/refund claims for remediating a contaminated real estate project. 18 Regs (d)(3) Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 5

6 not constitute the acquisition of other property. 19 Based on this, one may advance the position that prepaid real estate taxes and insurance premiums would be treated as cash items and qualify for the 75% asset test. In-Place Lease Values, Tenant Relationship Values, and Above-Market Leases For GAAP purposes, the purchase price of real estate is allocated to the acquired tangible assets (such as land and building) and identified intangible assets and liabilities. Among the intangible assets, it is not uncommon to see costs being allocated to in-place lease values, tenant relationship values, and above-market leases. It should be noted that the legislative history accompanying the enactment of 197 intangibles contained the following explanation suggesting these purchase accounting intangibles would be treated as part of the real estate for tax purposes: The term section 197 intangible does not include any interest as a lessor or lessee under an existing lease of tangible property (whether real or personal). The cost of acquiring an interest as a lessor under a lease of tangible property where the interest as lessor is acquired in connection with the acquisition of the tangible property is to be taken into account as part of the cost of the tangible property. For example, if a taxpayer acquires a shopping center that is leased to tenants operating retail stores, the portion (if any) of the purchase price of the shopping center that is attributable to the favorable attributes of the leases is to be taken into account as a part of the basis of the shopping center and is to be taken into account in determining the depreciation deduction allowed with respect to the shopping center. 20 For REIT qualification purposes, these types of assets should be considered part of the value of the underlying tangible real property. 19 Id. 20 H. Rep , at (1993). Qualifying Income Classification The most common type of income earned by a new entity with very few assets is interest earned on bank deposits. This income, of course, is qualifying for purposes of the REIT 95% gross income test, but ordinarily would not qualify as real estate source income under the 75% test. On the other hand, if the cash deposit that created the income was received in exchange for issuing founder s stock, the interest income might qualify as temporary investment income for purposes of the 75% gross income test, as discussed above. However, income may arise from other sources that may not be so easily managed. For example, any income derived from the proceeds of a private borrowing (including interest on deposits) will not qualify as temporary investment income, since the underlying principal amount does not qualify as new capital (i.e., because it was not received pursuant to a stock or public debt issuance). A new entity may also derive gross income from recently assigned contract rights (e.g., management contracts), from settlement of assigned rights to a legal claim, from taxable reimbursements, or from other items. While these types of income sources are not likely to qualify as temporary investment income, in many cases a strong argument may be made that 856(c)(5)(J) should apply either to exclude the amounts from, or treat them as qualifying, under the REIT gross income tests. In PLR , amounts received from a newly organized REIT s external advisor could not be excluded from income under Rev. Rul as reimbursement of expenses, because the reimbursed amounts actually exceeded the REIT s expenses to which they related. Nonetheless, the IRS concluded that such amounts related to the REIT s core business of investing in real estate assets and did not reflect a participation in another active business. Although this ruling preceded the enactment of 856(c)(5)(J), the IRS concluded that the reimbursed amounts could be treated as qualifying income for purposes of the income tests. In a more recent ruling, PLR , the IRS relied on 856(c)(5)(J) to conclude that amounts received in settlement of a breach of contract claim (for selling defective mortgages) should be excluded from the REIT s gross income tests. In fact, one would expect that most forms of gross income that a new REIT is likely to accrue should be given favorable treatment under 856(c)(5)(J), provided the amounts are closely related to the REIT s intended real estate investment activities or necessary corporate activities leading up to the stock offering. The problem, however, is that this provision only authorizes the Secretary of the Treasury to grant such treatment. To rely on this provision, presumably a taxpayer would need to obtain a private ruling beforehand, or roll the dice and rely on the good graces of the IRS at some later time. The former is usually not a practical alternative within the timeframe of an IPO, and the latter is clearly not an acceptable risk prior to an IPO C.B Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

7 S Corporation Election One alternative that many new REITs have employed to manage these various risks has been to make an S corporation election for the new entity. This election is maintained until on or about the date of the IPO transaction. Shortly before the planned stock offering, the election is revoked this terminates S status on the close of the day preceding the termination. 22 Thereafter, the entity begins a new tax year. Its REIT election will be retroactive to the first day of the new, short tax year. This alternative at least permits the entity to delay the beginning of the application of the REIT tests until it has closed the public offering (or immediately before). The proceeds of the offering (and any stock or debt instrument into which they are initially invested) will qualify as new capital and any earnings thereon should qualify under both the REIT 95% and 75% gross income tests, as temporary investment income for a period of 12 months following the offering. This alternative has been described in IRS rulings, with tacit approval. For example, in PLR , the IRS stated, Taxpayer is a newly-formed domestic corporation organized in Year 1 that has elected to be taxed as an S corporation commencing with its first tax year. Shortly before an initial public offering of Taxpayer s stock, its S corporation status will be terminated and Taxpayer will elect to be treated as a real estate investment trust ( REIT ) for its tax year ending Date 1. It should be noted that the general rule is for the corporation to allocate income or loss for the entire year on a pro rata basis (i.e., between the S short year and C short year). 23 However, the corporation may allocate its S termination year income on the basis of its normal tax accounting method (i.e., close of book) if (1) an election is made with the consent of each person who is a shareholder in the corporation at any 22 Regs (a) (e)(2). time during the S short year and of each person who is a shareholder in the corporation on the first day of the C short year, or (2) there is a change in ownership of 50% or more of the issued and outstanding shares of stock of the corporation. 24 With the IPO proceeds invested in income-producing properties, a pro rata allocation presents a risk for the shareholders during the S short year to be allocated income without corresponding cash. Thus, it would be ideal to ensure the close-of-book method (rather than the pro rata allocation) will apply. 25 SUMMARY As acknowledged in most prospectuses issued by publicly traded REITs, the REIT rules are highly technical and complex, and there are limited judicial and administrative interpretations. Structuring alternatives, such as making a temporary S corporation election for a new entity, may not be available in all cases and may present their own potential foot-faults. In any case, the day after closing an IPO is not the time to discover a potential violation of a REIT qualification requirement that occurred a month earlier. Compliance with the REIT rules should be closely monitored beginning on the day the new entity is formed. One ignores such rules at one s own risk... and at the risk of thousands of new public shareholders. 24 Regs (b). 25 See James S. Eustice and Joel D. Kuntz, Federal Income Taxation of S Corporations, which discusses: Revocation before going public. Revocation of an S election may be particularly important before a corporation issues stock to the public. Having more than seventy-five shareholders will end an S election, but closing the corporation s books requires the consent of all shareholders on the first day of the C short year. Thus, an S corporation generally will not wish to have a large number of uncontrollable new shareholders on the first day of the C short year. The solution is to revoke the S election before shares are issued to the public. The revocation should take effect before any shares have been issued to underwriters or to the public. On the other hand, the revocation should not be made until the corporation is fairly sure that the public offering will be completed Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 7