PLR 200730016: S corporation retains status after IRA briefly holds its shares

Plain-English summary

An S corporation issued shares to an individual retirement account, which is not an eligible S corporation shareholder. Its accountant later identified the problem, and the IRA beneficiary bought the shares personally. The IRS found that the IRA's acquisition terminated the S election but that the termination was inadvertent under section 1362(f). It treated the corporation as continuing to be an S corporation from the acquisition date onward, provided its original election was valid and no other termination occurred. The ruling relied on representations that the transfer was not tax motivated and that the corporation and shareholders would make any required adjustments.

Ruling snapshot

• Question: Could the corporation preserve its S election after an IRA temporarily became a shareholder?
• Outcome: Approved; the inadvertent termination was disregarded subject to stated conditions.
• Key authorities: IRC §§ 1361, 1362(f); Rev. Rul. 92-73

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200730016
Third Party Communication: None
Release Date: 7/27/2007
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Refer Reply To:
CC:PSI:B1
PLR-152479-06
Date: April 19, 2007

Legend:

A = -------------------
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X = ---------------------------------
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Y = -------------------------

Date 1 = ----------------------

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

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

Date 4 = ---------------------

Month = --------------------

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

This letter responds to your letter dated November 2, 2006, and subsequent correspondence, on behalf of X, requesting relief under section 1362(f) of the Internal Revenue Code.

Facts:
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According to the representations submitted, X elected under § 1362(a) to be an S corporation effective Date 1. On Date 2, X issued shares to Y, an individual retirement account (“IRA”) for the benefit of A. X represents that it did not realize at the time of the transfer that Y was not an eligible S corporation shareholder. In Month, the accountant preparing X’s Form 1120S for the year ending Date 3 alerted X to the fact that Y was not an eligible shareholder. On Date 4, A purchased the X shares, individually, from Y.

X is requesting a ruling granting relief under § 1362(f) for an inadvertent termination of its S corporation election as a result of an ineligible shareholder, Y, acquiring stock of X. X represents that the transfer of X stock to the IRA was not motivated by tax avoidance or retroactive tax planning. X also represents that at all times it has acted and filed consistently with its belief that it was an S corporation effective Date 1. Specifically, A reported Y’s share of income on A’s federal income tax return. Furthermore, X and A both treated A as the owner of X stock. X and its shareholders agree to make any adjustments, consistent with the treatment of X as an S corporation, which the Secretary may require.

Law and Analysis:

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 an S corporation cannot 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.

Rev. Rul. 92-73, 1992 C.B. 224, holds that a trust that qualifies as an individual retirement account under § 408(a) is not a permitted shareholder of an S corporation under § 1361.

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.

Section 1362(f) provides that if (1) an election under § 1362(a) by an corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 termination, steps were taken so that the corporation is once more 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 pursuant to § 1362(f), agrees to make any adjustments
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(consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the circumstances resulting in the termination, the corporation shall be treated as continuing to be an S corporation during the period specified by the Secretary.

Conclusion:

Based solely upon the facts submitted and the representations set forth above, we conclude that X’s S election terminated on Date 2 when Y, an ineligible shareholder, acquired X stock. We also conclude that the termination of X’s S election constituted an inadvertent termination within the meaning of § 1362(f).

Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 2 and thereafter, provided that X’s subchapter S election was valid and was not otherwise terminated under § 1362(d).

Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of the above-described facts under any other provision of the Code. Specifically, no opinion is expressed on whether X is or was otherwise eligible to be an S corporation.

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

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

Sincerely,

Audrey W. Ellis
Senior Counsel, Branch 1
Office of Associate Chief Counsel
Passthroughs & Special Industries

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