PLR 200718020: IRA share transfers treated as inadvertent S termination

Plain-English summary

An S corporation lost its S election when a shareholder transferred stock to two IRAs, which could not be eligible S corporation shareholders. After learning of the problem, the IRAs transferred the shares to individuals. The IRS found the termination inadvertent and ruled that the corporation could continue to be treated as an S corporation during the intervening period and afterward, provided its original election was valid and no other termination occurred. The relief required the IRA beneficiaries and other shareholders to report the intervening period consistently with S corporation treatment.

Ruling snapshot

• Question: Could the corporation retain S treatment after its shares were temporarily held by ineligible IRAs?
• Outcome: Approved; the termination was found inadvertent, subject to consistent shareholder tax treatment.
• Key authorities: IRC §§ 1361(b)(1)(B), 1362(f), 1366-1368; Treas. Reg. § 1.1362-4(b).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200718020
Third Party Communication: None
Release Date: 5/4/2007
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------
----------------------, ID No. -------------
--------------------------
Telephone Number:
------------
---------------------
-----------------------
Refer Reply To:
CC:PSI:B03
PLR-145677-06
-
Date: January 30, 2007

LEGEND:

X = --------------------------
--------------------------------------------------

Shareholders:

----------------------
----------------------------------

-----------------------------------------------
--------------------------------

---------------------
----------------------------------

-----------------------
----------------------------------

------------------
----------------------------------

--------------------
----------------------------------

------------------------
----------------------------------

PLR-145677-06
2

------------------------
----------------------------------

----------------------
----------------------------------

---------------------
----------------------------------

---------------
----------------------------------

-------------------
----------------------------------

----------------------
----------------------------------

----------------
----------------------------------

---------------------
----------------------------------

----------------------------------
----------------------------------

-----------------------
----------------------------------

-------------------------------
----------------------------------

-----------------
----------------------------------

----------------------------
----------------------------------

-----------------------
----------------------------------

-------------------
----------------------------------

PLR-145677-06
3

----------------------
----------------------------------

--------------------
----------------------------------

----------------
----------------------------------

------------------------------------
----------------------------------

------------------
----------------------------------

----------------------
----------------------------------

-------------------
----------------------------------

--------------------
----------------------------------

---------------------------
----------------------------------

--------------------------
----------------------------------

-------------------
----------------------------------

---------------------
--------------------------

------------------------
----------------------------------

-------------------------------
--------------------------------

------------------------
----------------------------------

PLR-145677-06
4

-------------------
-----------------------------------

---------------------
----------------------------------

----------------------
----------------------------------

-------------------------
----------------------------------

--------------------
----------------------------------

-------------------------
----------------------------------

-----------------------
----------------------------------

-------------------------
----------------------------------

------------------------
----------------------------------

-----------------------------
----------------------------------

--------------------------
----------------------------------

---------------------------------
----------------------------------

--------------------------------
----------------------------------

IRA # 1 = ------------------------------

Beneficiary #1 = ------------------------
----------------------------------------------------------------------

PLR-145677-06
5

IRA # 2 = ---------------------------

Beneficiary #2 = ---------------------
----------------------------------------------------------------------

D1 = ------------------

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

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

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

D5 = -------------------

State = ------------

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

This letter responds to your letter dated September 21, 2006, and subsequent correspondence, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

Facts

X was incorporated under the laws of State on D1 and elected to be an S corporation, effective D2. On D3, a shareholder of X transferred his shares of X stock to IRA # 1 and IRA # 2 (collectively IRAs), ineligible shareholders under § 1361(b)(1)(B). In D4, X learned that its S corporation election had terminated on D3 when the IRAs became shareholders of X. Subsequently, on D5, the IRAs transferred their respective shares of X stock to individuals.

X represents that there was no tax avoidance or retroactive tax planning involved in the transfer of its stock to IRA # 1 and IRA # 2. In addition, 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(b)(1)(B) provides that, for purposes of subchapter S, the term "small business corporation" means a domestic corporation that is not an ineligible corporation and that does not, among other requirements, have as a shareholder a

PLR-145677-06
6

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) is terminated whenever (at any time on or after the first day of the first taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation. Section 1362(d)(2)(B) provides that any termination under §1362(d)(2)(A) is effective on and after the date of cessation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that the circumstances resulting in the 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 for which the termination occurred is a small business corporation; and (4) the corporation for which the termination occurred, and each person who was a shareholder in the corporation at any time during the period specified pursuant to § 1362(f), agree to make the adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to this period, then, notwithstanding the circumstances resulting in the termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.

Section 1.1362-4(b) of the Income Tax Regulations provides that for purposes of § 1.1362-4(a) the determination of whether a termination was inadvertent is made by the Commissioner. The corporation has the burden of establishing that under the relevant facts and circumstances the Commissioner should determine that the termination was inadvertent. The fact that the terminating event was not reasonably within the control of the corporation and was not part of a plan to terminate the election, or the fact that the event took place without the knowledge of the corporation, notwithstanding its due diligence to safeguard itself against such an event, tends to establish that the termination was inadvertent.

Conclusion

Based solely on the facts submitted and representations made, we conclude that X's S corporation election was terminated on D3 when IRA # 1 and IRA # 2, ineligible S corporation shareholders under § 1361(b)(1)(B), acquired stock in X. We also conclude that the termination was inadvertent within the meaning of § 1362(f). Consequently, we conclude that X will continue to be treated as an S corporation from D3 to D5, and thereafter, provided that X's S corporation election was valid and was not otherwise terminated.

This ruling is contingent on X treating Beneficiary 1 as owning the shares of X stock held by IRA # 1 and Beneficiary 2 as owning the shares of X stock held by IRA # 2, from the period of D3 to D5 and on Shareholders treating X as an S corporation effective D3. Accordingly, Shareholders, in determining their respective

PLR-145677-06
7

income tax liabilities, must include their pro rata share of the separately and nonseparately computed items of X under § 1366, make any adjustments to stock basis under § 1367, and take into account any distributions made by X under § 1368.

Except for the specific ruling above, no opinion is expressed or implied concerning the federal tax consequences of the facts of this case under any other provision of the Code. Specifically, no opinion is expressed or implied regarding X's eligibility to be an S corporation.

Under a power of attorney on file with this office, we are sending a copy of this letter to your authorized representatives.

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3), this ruling may not be used or cited as precedent.

Sincerely,

/s/

Mary Beth Collins
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2)
A copy of this letter
A copy for § 6110 purposes