PLR 200334002: Inadvertent stock transfer does not permanently end S election

Plain-English summary

A corporation's S election ended when its stock was transferred to an ineligible shareholder. After discovering the termination, the corporation took steps to eliminate the ineligible ownership. The IRS treated the termination as inadvertent under § 1362(f) and ruled that the corporation would continue as an S corporation from the transfer date onward, assuming its election was valid and did not otherwise end. The temporary owner was to be treated as a shareholder during its ownership period. The IRS expressed no view on whether the corporation otherwise qualified for S status.

Ruling snapshot

• Question: Does a temporary ineligible shareholder permanently end the corporation's S election?
• Outcome: Approved: continued S treatment under inadvertent termination relief.
• Key authorities: IRC §§ 1361(b)(1)(B), 1362(d)(2), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200334002
Washington, DC 20224
Release Date: 8/22/2003
Index Number: 1362.02-02
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:B1-PLR-107943-03
Date:
April 3 2003

Legend

X =

Y =

State =

D1 =

D2 =

D3 =

Dear
,

This responds to the letter dated January 28, 2002, submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue Code ("Code") for inadvertent termination of S election.

FACTS

The information submitted discloses that X is a corporation organized under the laws of the State, which elected to be treated as a Subchapter S corporation effective D1. On D2, all of X's stock was transferred to Y. As of D2, Y was an ineligible shareholder under § 1361(b)(1)(B) of the Code. As a result of Y becoming an X shareholder, X's S election terminated as of D2. On D3, X discovered that its S corporation status had terminated, and soon after took steps to eliminate Y as an ineligible shareholder.

PLR-107943-03
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LAW AND ANALYSIS

Section 1361(a)(1) defines an "S corporation", with respect to any taxable year, as a small business corporation for which an S election under § 1362(a) is in effect for such year. Section 1361(b)(1)(B) provides that a small business corporation may 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 taxable year for which the corporation is an S corporation) the corporation ceases to be a small business corporation. Under § 1362(d)(2)(B) the termination is effective on and after the day of the cessation.

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 in 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 such 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 consequence of a termination if no tax avoidance would result from the continued subchapter S treatment. In granting a waiver, it is hoped that the 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.

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

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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 Subchapter S election terminated upon the transfer of a portion of its stock to Y on D2. We also conclude that the termination constituted an "inadvertent termination" within the meaning of § 1362(f).

Further, we conclude that, pursuant to § 1362(f), X will be treated as continuing to be an S corporation from D2 and thereafter, assuming X's S corporation election is valid and not otherwise terminated under § 1362(d). In addition, Y should be treated as the shareholder of the S corporation during the period for which it held X’s stock.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of the facts described above under any other provision of the Code. Specifically, no opinion is expressed concerning whether X is a valid S corporation.

This ruling is directed only to the taxpayer who requested 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,

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

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