PLR 200316030: Inadvertent S corporation termination is waived

Plain-English summary

An S corporation's election terminated when an ineligible shareholder briefly held some of its stock. The shares were later transferred to another shareholder, and the corporation and its shareholders had consistently treated the company as an S corporation. The IRS concluded that the termination was inadvertent and ruled that the corporation would continue to be treated as an S corporation from the transfer date, provided its election was not otherwise terminated. The letter does not decide whether the original S election was valid.

Ruling snapshot

• Question: Would an ineligible shareholder's temporary ownership end the corporation's S status?
• Outcome: Approved: the termination was inadvertent and S treatment continues under § 1362(f).
• Key authorities: IRC §§ 1361(b)(1), 1362(d)(2), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200316030
Washington, DC 20224
Release Date: 4/18/2003
Index Number: 1362.02-02 Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:B01-PLR-150413-02
Date:
January 10, 2003

Legend

X
=

State =

Date 1 =

Date 2 =

A
=

B
=

C
=

a
=

Dear
:

This letter responds to a letter, dated September 10, 2002, written on behalf of X, requesting a ruling under section 1362(f) of the Internal Revenue Code.

Facts

According to the information submitted, X is a corporation organized under the laws of State. X elected to be treated as an S corporation effective Date 1. On Date 2, A transferred a shares of X stock to B, an ineligible shareholder, terminating X’s S election. The a shares of X stock were then transferred from B to C.

X represents that it has timely and consistently filed its tax returns consistent with its treatment as an S corporation. Further, X represents that at all times since Date 1, X and all of its shareholders treated X as a valid S corporation. In addition, C will report 2
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its pro rata share of X’s items of income, loss, deduction and credit as if the transfer of stock had been directly from A to C.

Law and Analysis

Section 1361(a)(1) defines an S corporation as a small business corporation for which an election under section 1362(a) is in effect. Section 1361(b)(1) defines "small business corporation" as a domestic corporation that is not an ineligible corporation and that does not (A) have more than 75 shareholders, (B) have as a shareholder a person (other than an estate, other than a trust described in section 1361(c)(2), and other than an organization described in (c)(6)) who is not an individual, (C) have a nonresident alien as a shareholder, and (D) have more than one class of stock.

Section 1362(d)(2)(A) of the Code provides that an election to be treated as an 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) the corporation ceases to be a small business corporation. The termination is effective on and after the date the S corporation ceases to meet the requirements of a small business corporation. Section 1362(d)(2)(B).

Section 1362(f) provides that a corporation is treated as continuing to be an S corporation during the period specified by the Secretary if (1) an election under section 1362(a) by any corporation was terminated under paragraph (2) or (3) of section 1362(d), (2) the Secretary determines that the termination was inadvertent, (3) no later than a reasonable period of time after discovery of the terminating event, 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 section 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 that period.

S. Rep. No. 640, 97th Cong., 2d Sess. 12-13 (1982), 1982-2 C.B. 718, 723-24, in discussing section 1362(f) of the Code, provides, in part, 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 3
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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 the corporation again became eligible for subchapter S treatment, depending on the facts.

Conclusions

Based upon the information submitted and the representations set forth above, we conclude that the termination of X's S corporation election was inadvertent within the meaning of section 1362(f).

Pursuant to section 1362(f), X will be treated as continuing to be an S corporation from Date 2, and thereafter, provided that X's subchapter S election is not otherwise terminated under section 1362(d).

Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of the above-described facts under any other provision of the Code. In particular, no opinion is expressed or implied concerning whether X's S election was valid under section 1362.

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

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent to the taxpayer.

Sincerely,

/s/ David R. Haglund

David R. Haglund
Senior Technician Reviewer, Branch 1
Office of the Assistant Chief Counsel
(Passthroughs and Special Industries

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes