PLR 200535002: Transfer to a partnership causes inadvertent S termination

Plain-English summary

An S corporation's shares were transferred to a family limited partnership, an ineligible S corporation shareholder. After the problem was discovered, the shares were transferred to the partnership's individual partners. The IRS concluded that the partnership transfer terminated the S election but treated the termination as inadvertent under section 1362(f). It allowed the corporation to continue as an S corporation during the interval, provided its original election was valid, no other termination occurred, and the corporation and shareholders reported items, basis changes, and distributions consistently with that treatment. The ruling would become void if they failed to do so.

Ruling snapshot

• Question: Could the corporation retain S treatment after an inadvertent share transfer to an ineligible partnership?
• Outcome: Approved: S treatment continued during the specified interval, subject to the stated conditions.
• Key authorities: IRC §§ 1361(b)(1)(B), 1362(d)(2), 1362(f), 1366–1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200535002
Release Date: 9/2/2005
Index Number: 1362.04-00

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Person To Contact:
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Refer Reply To:
CC:PSI:B02 – PLR-103402-05
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Date:
May 16, 2005

X = ------------------------
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P = -------------------------------------------------
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A = ---------------------
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B = ----------------------
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C = ------------------
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D = -----------------------------------
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D1 = -------------------

D2 = -----------------

D3 = ----------------------

D4 = ---------------------------

Dear -----------:

This letter responds to a letter dated December 2, 2004 and subsequent correspondence, submitted on behalf of X, requesting a ruling under ' 1362(f) of the Internal Revenue Code.

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The information submitted states that X was incorporated on D1 and elected to be treated as an S corporation effective D2. On D3 shares of X were transferred to P, a family limited partnership. Upon discovering that the shares had been transferred to an ineligible shareholder, on D4 the shares of X were transferred to individuals A, B, C and D, the partners of P.

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. X and all of X’s shareholders 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(f) provides that if (1) an election under ' 1362(a) by any corporation was terminated under ' 1362(d)(2) or 1362(d)(3); (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.

Based solely on the facts and the representations submitted, we conclude that X's S corporation election terminated on D3 under ' 1362(d)(2), when shares of X were transferred to P, an ineligible shareholder. 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 from D3 to D4 provided that X=s S corporation election was valid and provided that the election was not otherwise terminated under ' 1362(d). During the period from D3 to D4, A, B, C and D will be treated as the owners of the X stock. Therefore, the shareholders of X, must include their pro rata share of the separately stated and nonseparately computed items of X as provided in ' 1366, make any adjustments to basis as provided in ' 1367, and take into account any distributions

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PLR-103402-05

made by X as provided in ' 1368. If X or its shareholders fail to treat X as described above, this letter ruling will be null and void.

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’s authorized representative.

Sincerely,

Beverly Katz
Senior Technician Reviewer, Branch 2
Office of Associate Chief Counsel

(Passthroughs & Special Industries)

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