PLR 200252078: Inadvertent S election termination receives continued status relief

Plain-English summary

An S corporation had accumulated earnings and profits and more than 25 percent passive investment income for three consecutive years, which terminated its S election. It later paid the related section 1375 tax and distributed its accumulated earnings and profits to its sole shareholder. The IRS ruled that the termination was inadvertent and that the corporation would be treated as continuing its S status from the termination date, provided the original election was valid and no other termination occurred. The IRS required no adjustments or amendments to the specified year's returns, but said its ruling would be void if the conditions were not met.

Ruling snapshot

• Question: Could the corporation retain S status after an inadvertent termination caused by three years of excess passive income?
• Outcome: Approved, subject to the validity and continuing status conditions in the letter.
• Key authorities: IRC §§ 1362(d)(3), 1362(f), 1375.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200252078
Washington, DC 20224
Release Date: 12/27/2002
Index Number: 1362.04-00 Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:2 - PLR-100477-02
Date:
September 24, 2002

X
=

A
=

D1 =

D2 =

D3 =

Year 1 =

Year 2 =

Year 3 =

Year 4 =

Dear
:

This letter responds to a letter dated August 8, 2002, and prior correspondence, submitted on behalf of X , requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated on D1. X elected to be treated as an S corporation effective D2. X had subchapter C earnings and profits at the close of each of its Year 1, Year 2, and Year 3 taxable years, and had gross receipts for each of those years more than 25 percent of which were passive investment income. As a result, X’s S election terminated on D3. X represents that the termination of X’s election to be an S corporation was inadvertent, unintended, and not the result of tax avoidance or retroactive tax planning. In Year 4, X paid the tax under § 1375 for Year 1, Year 2, and Year 3 and distributed all of X’s subchapter C earnings

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and profits to A, X’s sole shareholder. X and A agree to make any adjustments consistent with the treatment of X as an S corporation as may be required by the Secretary.

Section 1361(a)(1) defines an "S corporation" as a small business corporation for which an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a "small business corporation" means a domestic corporation that is not an ineligible corporation and that 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)(3)(A)(i) provides that an election under § 1362(a) shall be terminated whenever the corporation has accumulated earnings and profits at the close of each of three consecutive taxable years, and has gross receipts for each of such years more than 25 percent of which are passive investment income. Section 1362(d)(3)(A)(ii) provides that any termination under § 1362(d)(3) shall be effective on and after the first day of the first taxable year beginning after the third consecutive taxable year referred to in § 1362(d)(3)(A)(i).

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2); (2) the Secretary determines that the circumstances resulting in such 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 under § 1362(f), agrees to make the adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary for that period, then, notwithstanding the circumstances resulting in such termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.

Section 1375 imposes a tax on the income of an S corporation that has accumulated earnings and profits at the close of a taxable year, and that has gross receipts more than 25 percent of which are passive investment income (within the meaning of § 1362(d)(3)).

Based solely on the representations made and the information submitted, we conclude that X's S corporation election terminated on D3 under § 1362(d)(3)(A), because X had subchapter C earnings and profits at the close of each of three consecutive taxable years, and had gross receipts for each of those taxable years more than 25 percent of which were passive investment income.

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We further conclude that the termination of X's S corporation election was an inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation beginning D3, and thereafter, provided that X's S corporation election was valid and is not otherwise terminated under § 1362(d). Based on the particular facts of this case, no adjustments are required under § 1362(f)(4). Furthermore, no amendments shall be made to X's or A’s Year 3 income tax returns with respect to the issues addressed in this letter. If these conditions are not met, then this ruling is null and void. Furthermore, if these conditions are not met, X must notify the Service Center with which X's S corporation election was filed that the election terminated on D3.

Except as specifically ruled upon above, no opinion is expressed concerning the federal income tax consequences of the above-described facts under any other provision of the Code.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) 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 X.

Sincerely yours,

J. THOMAS HINES
Chief, Branch 2
Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes