PLR 200030020: Inadvertent S corporation termination receives relief

Plain-English summary

An S corporation issued stock to a nonresident alien, who could not be an S corporation shareholder. The corporation said it had intended to maintain its S status and redeemed that shareholder's entire interest promptly after discovering the problem. The IRS found that the issuance terminated the S election but that the termination was inadvertent under section 1362(f). It allowed continuous S corporation treatment from the termination date if income, deductions, and credits otherwise allocable to that shareholder were allocated to the other shareholders as if the ineligible shareholder had never owned stock, and if no other termination occurred. The IRS did not decide whether the corporation's original S election was valid.

Ruling snapshot

• Question: Could the corporation retain S treatment after inadvertently issuing stock to an ineligible nonresident alien?
• Outcome: Approved conditionally under the inadvertent termination relief rule.
• Key authorities: IRC §§ 1361(b)(1)(C), 1362(d)(2), and 1362(f).

Full text (IRS public release)

Internal Revenue Service                         Department of the Treasury

Index Number: 1362.04-00                         Washington, DC 20224

Number: 200030020                                Person to Contact:
Release Date: 7/28/2000                          Telephone Number:

Refer Reply To:
CC:DOM:P&SI:1-PLR-102450-00
Date:
May 01, 2000

Legend:

X             =

A             =

D1            =

D2            =

State         =

This responds to the letter dated December 28, 1999, and subsequent
correspondence, submitted on behalf of X requesting relief under § 1362(f) of the Internal
Revenue Code.

FACTS

You have represented that the facts are as follows. X is a corporation incorporated
under the laws of State on D1 and which made a valid S corporation election effective D1.
On D2, X acquired the operating assets of an unrelated entity and issued stock to A, a
nonresident alien. X, its incorporators and shareholders intended for X to be an S
corporation before and after the issuance of the X stock to A. When it was discovered that
A was not a permissible S corporation shareholder, immediate steps were taken to redeem
A’s entire interest in X at a price equal to A’s original purchase price for the stock. No
distributions were made to A during the period for which A held stock in X. X and all of its
shareholders have agreed to make such adjustments as are determined appropriate for

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X to retain its S status.

LAW AND ANALYSIS

Section 1361(a)(1) defines an “S corporation” as “a small business corporation for
which an election under § 1362 is in effect.”

Section 1361(b)(1)(C) provides that, in order to be a small business corporation, a
taxpayer cannot have a nonresident alien as a shareholder.

Section 1362(d)(2)(A) provides that an election to be treated as a subchapter S
corporation terminates whenever (at any time on or after the first day of the first taxable
year for which the corporation is an S corporation) such corporation ceases to be a small
business corporation. Under §1362(d)(2)(B), the termination is effective on and after the
date the S corporation ceases to meet the requirements of a small business corporation.

Section 1362(f), in relevant part, provides that, if (1) an election under §1362(a) by
any corporation was terminated under § 1362(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 the 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 §1362(f),
agrees to make any adjustments (consistent with the treatment of the corporation as an
S corporation) as may be required by the Secretary with respect to the period, then,
notwithstanding the terminating event, the corporation shall be treated as continuing to be
an S corporation during the period specified by the Secretary.

The committee reports accompanying the Subchapter S Revision Act of 1982
explain §1362(f) as follows:

If the Internal Revenue Service determines that a corporation’s
subchapter S election is inadvertently terminated, the Service can waive the
effect of the terminating event for any period if the corporation timely corrects
the event and if the corporation and the shareholders agree to be treated as
if the election had been in effect for such period.

The committee intends that the Internal Revenue Service be
reasonable in granting waivers, so that corporations whose subchapter S
eligibility requirements have been inadvertently violated do not suffer the tax
consequences of a termination if no tax avoidance would result from the
continued subchapter S treatment. In granting a waiver, it is hoped that
taxpayers and the government will work out agreements that protect the
revenues without undue hardship to taxpayers....It is expected that the waiver
may be made retroactive for all years, or retroactive for the period in which

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the corporation again became eligible for subchapter S treatment, depending
on the facts.

S. Rep. No. 640, 97th Cong., 2d Sess. 12-13 (1982), 1982-2 C.B. 718, 723-24; H.R. Rep.
No. 826, 97th Cong., 2d Sess. 12 (1982), 1982-2 C.B. 730, 735.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude
that X’s election to be treated as an S corporation terminated on D2 when X’s stock was
issued to A. We also conclude that the termination constituted an “inadvertent termination”
within the meaning of § 1362(f). Pursuant to § 1362(f), X will be treated as continuing to
be an S corporation from D2, provided that the items of income, deduction, and credit of
the S corporation which would have been allocated to A are allocated to the other
shareholders in accordance with their stock ownership in X (as if A had not been a
shareholder), and that X’s S election is not otherwise terminated under § 1362(d).

Except as expressly provided herein, no opinion is expressed or implied concerning
the tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed concerning whether the original election
made by X to be treated as an S corporation was a valid election under § 1362.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representative.

Sincerely,

Signed/Dianna K. Miosi
Dianna K. Miosi
Chief, Branch 1
Office of the Assistant Chief Counsel
(Passthroughs and Special Industries)
Enclosures (2)
Copy of this letter
Copy for § 6110 purposes