PLR 200834007: Corporation received relief for an inadvertent S election termination

Plain-English summary

An S corporation's stock was held partly through a single-member LLC owned by its original shareholder. When that owner sold LLC interests to two other people, the LLC stopped being disregarded and became an ineligible S corporation shareholder. The IRS ruled that the resulting S election termination was inadvertent and allowed the corporation to retain S status. Relief required treating the individuals as proportionate owners of the stock held by the LLC and consistently reporting S corporation items, basis adjustments, and distributions. Failure to follow those conditions would make the ruling void.

Ruling snapshot

• Question: Could the corporation retain S status after its shareholder LLC ceased to be disregarded and became ineligible?
• Outcome: Approved as an inadvertent termination, subject to consistent shareholder treatment and reporting
• Key authorities: IRC §§ 1361, 1362(f), and 1366-1368

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200834007
Third Party Communication: None
Release Date: 8/22/2008
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-108468-08
Date: May 15, 2008

Company = ----------------------
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LLC = ----------------------------------

A = ----------------------
------------------------------------
B = -------------------

C = ------------------

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

a = ----------------------------

b = ----------------------------

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

We received a letter dated January 25, 2008, and subsequent correspondence submitted on behalf of Company by its authorized representative requesting a ruling under § 1362(f) of the Internal Revenue Code. This letter responds to that request.

FACTS

The information submitted states that Company was formed on a, under the laws of State. Upon formation, Company filed Form 2553, Election by a Small Business Corporation, to be treated as a subchapter S corporation effective on a. Company’s
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initial shareholder was A, who owned Company stock directly and indirectly through LLC, a disregarded entity wholly owned by A. However, on b, A sold interests in LLC to B and C, which resulted in LLC no longer being treated as a disregarded entity. As a result, Company had an ineligible shareholder, LLC.

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

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) provides that the term “small business corporation” means a domestic corporation which is not an ineligible corporation and which 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 1362(d)(2)(A) provides that 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. Section 1362(d)(2)(B) provides that any termination 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 (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) or § 1361(b)(3)(C), (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 for which the election was made or the termination occurred is a small business corporation or a qualified subchapter S subsidiary, as the case may be, and (4) the corporation for which the election was made or the termination occurred, and each person who was a shareholder in the corporation at any time during the period specified pursuant to § 1362(f), agrees to make adjustments (consistent with the treatment of the corporation as an S corporation or a qualified subchapter S subsidiary, as the case may be) as may
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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 or a qualified subchapter S subsidiary, as the case may be, during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that Company’s election to be treated as an S corporation terminated on b, when LLC became an ineligible S corporation shareholder. We also conclude that the termination constituted an inadvertent termination within the meaning of § 1362(f). Accordingly, Company will be treated as continuing to be an S corporation from b, and thereafter, provided that Company’s S corporation election is not otherwise terminated under § 1362(d). This ruling is contingent upon A, B, and C being treated as owning Company stock held by LLC in proportion to their ownership interests in LLC on b, and thereafter; and upon Company and all its shareholders treating Company as having been an S corporation for the period beginning on b, and thereafter. The shareholders of Company must include their pro rata share of the separately stated and nonseparately computed items of Company as provided in § 1366, make any adjustments to basis as provided in § 1367, and take into account any distributions made by Company as provided in § 1368. If Company or Company’s shareholders fail to treat themselves as described above, this ruling shall be null and void.

Except as expressly provided herein, we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express or imply no opinion regarding whether Company 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.
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In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to Company’s authorized representative.

Sincerely,

/s/

James A. Quinn
Senior Counsel, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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