PLR 200605005: Partnership ownership caused inadvertent S election termination

Plain-English summary

Two owners transferred their interests in an S corporation to a partnership, which caused the S election to terminate because a partnership cannot be an eligible shareholder. They later transferred the interests back and represented that the corporation and shareholders had continued to file as an S corporation. The IRS ruled that the termination was inadvertent under section 1362(f). It treated the corporation as continuing to have S status from the date of termination, provided the election was not otherwise terminated.

Ruling snapshot

• Question: Can the corporation retain S status despite a temporary transfer of its ownership to a partnership?
• Outcome: Approved, the termination was inadvertent and S status continues subject to the stated condition.
• Key authorities: IRC §§ 1361(b)(1), 1362(d)(2), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200605005
Third Party Communication: None
Release Date: 2/3/2006
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B01
PLR-141702-05
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Date:
October 12, 2005

Legend

X = ---------------
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Y = ---------------------------
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A = --------------
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B = ---------------
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D1 = --------------------
D2 = ----------------------
D3 = -----------------

Dear --------------

This responds to the letter dated July 20, 2005, submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue Code.

Facts

X made an election to be treated as an S corporation effective D1. On D2, A and B transferred their membership interests in X to Y, a partnership for federal tax purposes, resulting in the termination of the S election of X. On D3, the membership interests in X held by Y were transferred to A and B.

X represents that at all relevant times, X and its shareholders treated X as an S corporation and filed their tax returns accordingly. X and its shareholders agree to make any adjustments consistent with the treatment of X as an S corporation as may be required by the Secretary with respect to the period specified by § 1362(f).

PLR-141702-05
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Law and Analysis

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which an election under § 1362(a) is in effect.

Section 1361(b)(1) defines a “small business corporation” as a domestic corporation which is not an ineligible corporation which does not (A) have more than 75 shareholders, (B) have as a shareholder a person (other than an estate and other than a trust described in subsection (c)(2)) who is not an individual, (C) have a nonresident alien as a shareholder, and (D) have more than 1 class of stock.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever 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) the Secretary determines that the circumstances resulting in the termination were inadvertent, (3) no later than a reasonable period of time after the 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 of inadvertent termination of the S election, agrees to makes 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 is treated as an S corporation during the period specified by the Secretary.

Conclusion

Based solely on the facts submitted and representation made, we conclude that X’s election to be treated as an S corporation terminated on D2. We also conclude that the termination constituted an “inadvertent termination” within the meaning of § 1362(f).

Under the provisions of § 1362(f), X will be treated as continuing to be an S corporation from D2, and thereafter, provided that X’s S corporation election is not otherwise terminated under § 1362(d).

Except as expressly provided herein, no opinion is expressed or implied as to the federal tax consequences of the facts described above under any other provision of the Code. In particular, no opinion is expressed as to whether X is an S corporation for federal tax purposes.

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

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3

Pursuant to the power of attorney on file with this office, a copy of this letter will be sent to X’s authorized representative.

Sincerely,

Dianna K. Miosi

Dianna K. Miosi
Chief, Branch 1
Associate Chief Counsel
(Passthroughs and Special Industries)
Enclosures (2):
Copy of this letter,
Copy for § 6110 purposes