PLR 200807002: S corporation gets relief after shares were issued to an IRA

Plain-English summary

An S corporation accidentally issued shares to an individual retirement account instead of to an eligible individual shareholder. Because the IRA was an ineligible shareholder, the corporation's S election terminated when it received the shares. The corporation later redeemed those shares and issued the same number to the intended individual. The IRS found the termination inadvertent and allowed S corporation treatment to continue under section 1362(f), assuming the election was otherwise valid. As a condition, the IRA must be treated as the shareholder for periods with a net loss, and the individual must be treated as the shareholder for periods with a net gain. The ruling becomes void if the corporation or shareholders fail to follow its required tax treatment and adjustments.

Ruling snapshot

• Question: Could an S corporation retain its election after stock was mistakenly issued to an IRA?
• Outcome: Approved, subject to the specified shareholder treatment and adjustments.
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, 1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200807002
Third Party Communication: None
Release Date: 2/15/2008
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------------------- -------------------, ID No. -------------
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Telephone Number:
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Refer Reply To:
In Re: CC:PSI:B02
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PLR-122732-07
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Date:
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November 05, 2007

Legend

X = ---------------------------------------------------------------------------------------------------
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IRA = ------------------------------------------------------------------

A = ----------------------------
-----------------------------------

State = --------------------------
Year 1 = -------

Date 1 = --------------------------------
Date 2 = ----------------------------

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

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

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

This letter responds to a letter dated April 4, 2007, together with subsequent correspondence, submitted by X's authorized representative on behalf of X, requesting inadvertent termination relief under § 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 on Date 1. On Date 2, X shares were inadvertently issued to IRA, an ineligible shareholder under § 1361(c)(1)(A), rather than to A, an eligible shareholder. X represents that upon discovery of the inadvertent error, it took remedial action. On Date 3, it redeemed all

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the stock issued to IRA, and on Date 4 it issued the corresponding number of shares to A.

X represents that the transfer of X stock to IRA, an ineligible shareholder, was not motivated by tax avoidance or retroactive tax planning. For all taxable years X and its shareholders continued to treat X as an S corporation. X and its shareholders agree to make any adjustments (consistent with the treatment of X as an S corporation) that the Secretary may require.

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

Section 1361(b)(1)(B) provides that a “small business corporation” cannot have as a shareholder a person (other than an estate and other than a trust described in § 1361(c)(2) or an organization described in § 1361(c)(6)) who is not an individual.

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

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 paragraph (2) or (3) of § 1362(d), (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 of 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, the corporation shall be treated as an S corporation during the period specified by the Secretary.

Based solely on the information submitted and the representations made, we conclude that X's S corporation election was terminated on Date 2 when IRA, an ineligible shareholder, acquired X stock. We also conclude that this termination was inadvertent within the meaning of § 1362(f), and that under the provisions of § 1362(f), X will be treated as an S corporation from Date 2, and thereafter, provided that X's S election was valid and was not otherwise terminated.

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As a condition for this ruling, for the tax periods beginning on or after Date 2 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 2 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 themselves as described above, this ruling shall be null and void.

Except as specifically ruled upon above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code. Specifically, no opinion is expressed on whether X was otherwise eligible to be treated as an S corporation.

This ruling is directed only to the taxpayer who requested it. Section § 6110(k)(3) of the Code 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,

Melissa Liquerman
Senior Technician Reviewer, Branch 2
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures: (2)

Copy of this letter

Copy for § 6110 purposes

cc: