PLR 200824007: Uneven shareholder payments do not end S treatment

Plain-English summary

After an S corporation gained additional shareholders, it kept making estimated tax payments on their behalf and made other distributions that did not match their ownership shares. The corporation later made corrective payments with interest to address the imbalance. It said all shares had identical rights under its governing documents and no shareholder had a special distribution agreement. The IRS did not decide whether the uneven payments actually created a second class of stock, but ruled that any resulting end of S status was inadvertent under § 1362(f). It allowed the corporation to continue S treatment from the stock sale date if its election was not otherwise terminated, while shareholders accounted for income, basis, and distributions under the S corporation rules.

Ruling snapshot

• Question: Would uneven shareholder payments end the corporation's S status?
• Outcome: Any termination caused by those payments was inadvertent, so S treatment continued subject to the ruling's limits.
• Key authorities: IRC §§ 1361(b)(1)(D) and 1362(f); Treas. Reg. § 1.1361-1.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200824007
Third Party Communication: None
Release Date: 6/13/2008
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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CC:PSI:B01
PLR-141700-07
Date: March 17, 2008

LEGEND

X = -------------------------
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A = -----------------------------
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B = -----------------------
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C = -----------------------
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D = ------------------------
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E = ------------------------
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Date 1 = ----------------

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

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

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

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

PLR-141700-07
2

Year = -------

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

This responds to a letter dated September 14, 2007, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

The information submitted states that X was incorporated on Date 1 in accordance with the laws of State. X elected to be an S corporation effective Date 1. From Date 1 until Date 2, A was the sole shareholder of X. During this time, X made estimated income tax payments directly to the State franchise tax board and the Internal Revenue Service on behalf of A. On Date 2, A sold shares of X to B, C, D, and E. Subsequent to Date 2, X continued making estimated tax payments on behalf of the shareholders. However, these distributions were not in accordance with the shareholders’ share ownership in X. X also made other distributions during Year to or on behalf of shareholders that were not in accordance with the ownership interests of the shareholders in X.

In Month, X’s accountant learned about the sale of X shares on Date 2 and discovered that X may have made distributions to or on behalf of shareholders that were not in accordance with the shareholders’ ownership interests in X. On Date 3, X made remedial distributions, to certain shareholders to correct the effect of the disproportionate distributions in Year. Interest payments were also made to account for the timing difference between the disproportionate and remedial distributions.

X represents that, under X’s articles of incorporation and by-laws and State law, all of the issued and outstanding shares of capital stock of X have identical rights to distribution and liquidation proceeds, and that X has never had any written or oral agreement, or any other type of understanding, with any shareholder that would entitle any shareholder to a preference regarding distribution and liquidation proceeds.

X represents that the circumstances resulting in the possible termination of the election were not motivated by tax avoidance or retroactive tax planning. X further represents that X and each of its shareholders have filed federal income tax returns consistent with the treatment of X as an S corporation at all times since Date 1. Finally, X and each of X’s shareholders agree to make any adjustments required by the Secretary consistent with the treatment of X as an S corporation.

LAW AND ANALYSIS

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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) defines a “small business corporation” as a domestic corporation that is not an ineligible corporation and that does not (A) have more than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more than one class of stock.

Section 1.1361-1(I)(1) of the Income Tax Regulations provides that a corporation is generally treated as having only one class of stock if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds.

Section 1.1361-1(I)(2)(i) provides that the determination of whether all outstanding shares of stock confer identical rights to distribution and liquidation proceeds is made based on the corporate charter, articles of incorporation, bylaws, applicable state law, and binding agreements relating to distribution and liquidation proceeds (collectively, the "governing provisions"). Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances.

Section 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall be 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 and (B) any termination under § 1362(d)(2) shall be 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 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 (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 will be treated as continuing to be an S corporation during the period specified by the Secretary.

CONCLUSION

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Based solely on the information submitted and the representations made, we conclude that X’s S corporation election may have terminated because X may have had more than one class of stock. However, we conclude that, if X’s S election was terminated, such termination was inadvertent within the meaning of § 1362(f).

Therefore, X will be treated as continuing to be an S corporation from Date 2, and thereafter, provided that X’s S election is not otherwise terminated under § 1362(d). 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 and non-separately 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.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, no opinion is expressed concerning whether X is otherwise eligible to be treated as an S corporation.

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

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representatives.

Sincerely,

/s/

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