PLR 200620005: S corporation status continues after one share reached an ineligible owner

Plain-English summary

One share of an S corporation's stock was bought by an ineligible shareholder, terminating its S election. The share was later transferred to an eligible shareholder. The IRS found the termination inadvertent under IRC § 1362(f) and treated the corporation as continuing to be an S corporation from the transfer to the ineligible owner onward, provided its election was not otherwise terminated. The corporation and shareholders agreed to make any required adjustments consistent with S corporation treatment.

Ruling snapshot

• Question: Could the company keep S status despite a temporary ineligible shareholder?
• Outcome: Approved, provided the S election was not otherwise terminated.
• Key authorities: IRC §§ 1361(b)(1), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200620005
Third Party Communication: None
Release Date: 5/19/2006
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-129099-05
Date:
January 26, 2006

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Legend

X = --------------------------------------------------
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Y = ----------------------------
D1 = -------------------
D2 = -----------------------
D3 = -------------------

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

This responds to the letter dated May 24, 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, one share of X’s common stock was purchased by Y, an ineligible shareholder. On D3, the share held by Y was transferred to an eligible shareholder.

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).

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.

PLR-129099-05
2

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 make- 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.

PLR-129099-05
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