PLR 200728027: IRA stock transfer caused an inadvertent S election termination

Plain-English summary

An owner transferred shares of an S corporation to an individual retirement account, which was not an eligible S corporation shareholder. The transfer ended the corporation's S election, though the owner and company did not realize it. The IRS found the termination inadvertent and allowed S treatment to continue from a later date for which the assessment period remained open, provided the original election was valid and no other termination occurred. The ruling requires specific treatment of the IRA and owner for loss and gain years, along with the usual shareholder income, basis, and distribution adjustments. The IRS said the ruling would be void if the company or shareholders failed to follow these conditions.

Ruling snapshot

• Question: Could the company regain S treatment after an owner's stock transfer to an IRA terminated its election?
• Outcome: Approved from the specified later date, subject to shareholder reporting conditions.
• Key authorities: IRC §§ 1361(b)(1)(B), 1362(d)(2), 1362(f), 1366, 1367, 1368

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200728027
Release Date: 7/13/2007

Index Number: 1362.04-00

Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:2 – PLR-146396-06
Date:
April 04, 2007

Legend:

X = --------------------
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A = ------------------------
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IRA = -----------------------------------------------------------------------------------------
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Date 1 = --------------------------

Date 2 = ------------------

Date 3 = ----------------------

State = ---------
PLR-146396-06
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Year 1 = -------

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

This responds to a letter dated September 13, 2006, submitted on behalf of X by its authorized representative, requesting relief pursuant to § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated under the laws of State on Date 1 and elected to be treated as an S corporation, effective Date 1. On Date 2, A transferred shares of X to an individual retirement account (IRA), an ineligible shareholder, for the benefit of A, thereby terminating X’s S election on Date 2. Both A and X were unaware that the transfer caused a termination. X and all its shareholders continued to treat X as an S corporation. The period of limitations on assessments under § 6501(a) has expired for the taxable years before Date 3. However, the period of limitations on assessments under § 6501(a) has not expired for the taxable years beginning on Date 3, or for any subsequent years.

X represents that the circumstances resulting in the termination of X's S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make such adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary.

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1361(a)(1) provides that the term "S corporation" means, with respect to any taxable year, a small business corporation for which an election under § 1362(a) is in effect for such year.

Section 1361(b)(1)(B) provides that the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which 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(d)(2)(A) provides that an election under § 1362(a) will be terminated whenever (at any time on or after the 1st day of the 1st 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 the termination shall be effective on and after the date of cessation.
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Section 1362(f) provides that if -- (1) an election under § 1362(a) by any corporation -- (A) was not effective for the taxable year for which made (determined without regard to § 1362(b)(2)) by reason of a failure to meet the requirements of § 1361(b) or to obtain shareholder consents, or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness or termination, steps were taken -- (A) so that the corporation is a small business corporation, or (B) to acquire the required shareholder consents, 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 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 such ineffectiveness or termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

Based solely on the representations made and the information submitted, we conclude that X's S corporation election terminated on Date 2, under § 1362(d)(2), because of the transfer of shares of X to an ineligible shareholder, and that this termination of X's S 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 Date 3 and thereafter, provided X's S corporation election was valid and was not otherwise terminated under § 1362(d).

As a condition for this ruling, for the tax periods beginning on or after Date 3 in which X reported a net loss, IRA will be treated as the shareholder of the shares of stock. For the tax periods beginning on or after Date 3 in which X reported a net gain, A will be treated as the shareholder of the shares of stock. All of X's shareholders in determining their respective income tax liabilities during the termination period and thereafter, must include their pro rata share of the separately stated items of income (including tax-exempt income), loss, deduction, or credit and non-separately stated computed items of income or loss of X as provided in § 1366, make any adjustments to basis provided in § 1367, and take into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat X as described above, this ruling will be null and void.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provision of the Code. Specifically, no opinion is expressed on whether X is otherwise eligible to be treated as an S corporation.
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This ruling letter is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Pursuant to the power of attorney on file with this office, a copy of this letter is being sent to X's authorized representative.

Sincerely,

Bradford R. Poston
Senior Counsel, Branch 2
Associate Chief Counsel
(Passthroughs and Special Industries)

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