You help prepare tax work for Wilkinson CPA$$s$,$ LLC out of Manhattan, KS$.$

Your client is Powercat Ranch, Inc. $($S$-$Corp, located in New Mexico, owned by $2$ shareholders $$ Terry and Sarah$).$ Powercat originally had a $12/31$ tax year$$end$.$ The client wanted to change their year$$end to $10/31$ for tax reporting purposes. The new year$-$end could potentially offer some tax planning strategies in regards to deferring taxable income. To accomplish this, Terry and Sarah created a new holding company, Four Pillars Ranch, LLC$,$ in Kansas, and contributed their ownership in Powercat Ranch, Inc. to the new holding company. In $2019,$ you filed a short year final federal return for Powercat Ranch, Inc. and later filed an initial return for Four Pillars Ranch, LLC$,$ beginning $11/1/19.$ You also filed a QSub election in $2019$ after Terry and Sarah transferred their ownership in Powercat Ranch, Inc. to Four Pillars Ranch, LLC$.$ You continue to file income tax returns for Powercat Ranch, Inc. in New Mexico. Four Pillars Ranch, LLC applied for and uses a new EIN.

Powercat Ranch, Inc. is a cash$-$basis taxpayer. Four Pillars, LLC is a cash$-$basis taxpayer as well. Four Pillars, LLC has no activity other than flow$-$through activity from Powercat Ranch, Inc. Both entities list their principal business activity as $$Ranching$$ on their tax returns.

Not long after this election and change had been made, Terry and Sarah$$s personal $2017$ return was pulled for IRS audit. The IRS then pulled all personal and business tax returns related to Terry and Sarah $($including Powercat Ranch, Inc and Four Pillars Ranch, LLC$)$ for years $20182020.$ The IRS$$s determination was that Four Pillars Ranch, LLC was $$substantially the same business$$ as Powercat Ranch, Inc. and therefore the $10/31$ year$$end was not approved.

Because Four Pillars Ranch, LLC also has to have a $12/31$ year$$end$,$ the new entity is basically useless. Powercat Ranch, Inc. did file a final federal return but is still an active company that files state tax returns and federal payroll filings. All business accounts are under Powercat Ranch, Inc., not Four Pillars Ranch, LLC$.$

What authority is the IRS relying on to determine that both companies are $$substantially the same business$$ and therefore a fiscal year$-$end election is not available?

What are Sarah and Terry$$s options to completely eliminate Four Pillars Ranch, LLC and go back to using only Powercat Ranch, Inc?