PLR 200845037: Ineligible shareholder caused an inadvertent S termination

Plain-English summary

An S corporation issued some stock to a shareholder that was not eligible to own S corporation shares, terminating its election. After discovering the problem, the company took steps within a reasonable time to become a qualifying small business corporation again. The company and its shareholders agreed to any adjustments the IRS might require for the affected period. The IRS ruled that the termination was inadvertent under § 1362(f) and treated the company as continuously maintaining S status, provided no other termination occurred.

Ruling snapshot

• Question: Could the corporation retain S status after stock was issued to an ineligible shareholder?
• Outcome: Approved. The termination was inadvertent, and S status continued subject to the stated condition.
• Key authorities: IRC §§ 1361 and 1362(f); Rev. Rul. 92-73

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200845037
Third Party Communication: None
Release Date: 11/7/2008
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00
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ID No. -------------
Telephone Number:
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Refer Reply To:
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CC:PSI:B01
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PLR-127020-08
Date:
July 31, 2008

Legend:

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

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

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

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

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

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

This responds to the letter dated June 12, 2008, submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue Code (“Code”).

Facts:

You have represented that the facts are as follows. X was incorporated on Date 1, and made an election to be treated as an S corporation effective Date 1. On Date 2, a portion of the stock of X was issued to Y, which was not an eligible S corporation shareholder. On or about Date 3, the termination of the S election was discovered and, on Date 4, steps were taken so that X became a small business corporation.

X and its shareholders have agreed to make any adjustments consistent with the treatment of X as an S corporation as may be required by the Secretary with respect to the period specified by § 1362(f).
PLR-127020-08
2

Law and Analysis:

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

Section 1361(b)(1) defines a “small business corporation” as 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 subsection (c)(2), or an organization described in subsection (c)(6)) who is not an individual, (C) have a nonresident alien as a shareholder, and (D) have more than 1 class of stock.

In Revenue Ruling 92-73, 1992-2 C.B. 224, the IRS held that a trust that qualifies as an IRA under § 408(a) is not a permitted shareholder of an S corporation.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the 1st day of the taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation.

Section 1362(f) provides in part that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d), (2) the Secretary determines that the circumstances resulting in the termination were inadvertent, (3) no later than a reasonable period of time after the discovery of the circumstances resulting in the termination, steps were taken so that the corporation for which the termination occurred is a small business corporation, and (4) the corporation for which the termination occurred, and each person who was a shareholder in such corporation at any time during the period of inadvertent termination of the S election, agrees to makes 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 the termination, the corporation is treated as an S corporation during the period specified by the Secretary.

Conclusion:

Based solely on the facts submitted and representations made, we conclude that X’s election to be treated as an S corporation terminated on Date 2. We also conclude that the termination constituted an “inadvertent termination” within the meaning of § 1362(f).

Under 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 S corporation election is not otherwise terminated under § 1362(d).
PLR-127020-08
3

Except as expressly provided herein, no opinion is expressed or implied as to the federal tax consequences of the facts described above under any other provision of the Code. In particular, no opinion is expressed as to whether X is an S corporation for federal tax purposes.

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 representatives.

Sincerely,

Dianna K. Miosi

Dianna K. Miosi
Chief, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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

cc: