PLR 200250007: S corporation status restored after LLC stock ownership

Plain-English summary

Several shareholders transferred S corporation stock to an LLC taxed as a partnership, which was not an eligible S corporation shareholder. After a new accounting firm discovered the problem, four shareholders bought the stock back from the LLC. The IRS found that the resulting termination of S status was inadvertent and allowed the corporation to be treated as an S corporation throughout the period. This depended on its original election remaining valid and on the company and shareholders reporting income, basis, and distributions consistently with S corporation treatment. The relief requires the company to remain otherwise eligible for S status.

Ruling snapshot

• Question: Can the corporation retain S status despite temporary ownership by an ineligible LLC?
• Outcome: approved, subject to valid eligibility and consistent shareholder reporting
• Key authorities: IRC §§ 1361(b)(1)(B), 1362(d)(2), 1362(f), 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Number: 200250007 Washington, DC 20224
Release Date: 12/13/2002
Index Number: 1362.02-02 Person to Contact:

Telephone Number:

Refer Reply To:
PLR-112397-02 CC:PSI:3
Date:
August 27, 2002

LEGEND

Company =

State
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Business =

Shareholders =

LLC
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a
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b
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c
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d
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e
=

Dear
:

This letter responds to a letter dated January 28, 2002, and subsequent correspondence, submitted on behalf of Company requesting a ruling under § 1362(f) of the Internal Revenue Code.

According to the information submitted, Company was incorporated in State on a, and engages in Business. Company filed an election under § 1362(a) to be treated as an S corporation effective as of e. Company currently has five shareholders, Shareholders.

On b, several of Company’s then shareholders transferred a total of c shares of Company stock to the LLC, an ineligible shareholder taxable as a partnership. As a consequence, Company’s S corporation election terminated on the date of the transfer of Company stock to the LLC.

The termination of Company’s S election was not discovered until Company changed accounting firms. To correct the terminating event, four of the Shareholders purchased the stock of Company from the LLC on d.

Company represents that the termination of its S corporation election was inadvertent and unintended. In addition, Company and its shareholders agree to make such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Service.

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1361(a)(1) provides that the term "S corporation" means, with respect to any taxable year, a small business corporation for which an election under § 1362(a) is in effect for such year.

Section 1361(b)(1)(B) provides that the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which does not have as a shareholder a person (other than an estate, a trust described in § 1361(c)(2), or an organization described in § 1361(c)(6)) who is not an individual.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the first taxable year for

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which the corporation is an S corporation) the corporation ceases to be a small business corporation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that the circumstances resulting in termination were inadvertent; (3) no later than a reasonable period of time after discovery of the circumstances resulting in the termination, steps were taken so that the corporation is 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 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 the termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.

Based solely on the facts submitted and the representations made, we conclude that Company's S corporation election was terminated on b, when shares of Company's stock were first transferred to an ineligible shareholder, the LLC. We further conclude that this termination was inadvertent within the meaning of § 1362(f).

Consequently, under the provisions of § 1362(f), Company will be treated as an S corporation from b to d, and thereafter, provided that Company's S corporation election is valid and is not otherwise terminated under § 1362(d). Accordingly, Company’s shareholders during this period must include their pro rata share of the separately and nonseparately computed items of Company under § 1366, make any adjustments to stock basis under § 1367, and take into account any distributions made by Company to the shareholders under § 1368. If Company or any of Company's shareholders fail to treat Company as described above, this ruling will be null and void.

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent to Company’s authorized representative.

This ruling is directed only to the taxpayer requesting it. Under § 6110(k)(3), it may not be used or cited as precedent.

Sincerely yours,
CHRISTINE ELLISON
Chief, Branch 3
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)
Enclosures (2):
Copy of this letter
Copy for § 6110 purposes cc: