CCA 200913043: Effects of valid or invalid S corporation elections for an LLC

Plain-English summary

Chief Counsel analyzed an LLC's entity-classification and S corporation elections under two possible outcomes. If the classification election was unauthorized and invalid, the LLC defaulted to partnership status and was a TEFRA partnership because its partners included passthrough entities. The IRS then would issue a final partnership administrative adjustment within three years after a partnership return was filed. If the S election was valid, the IRS instead would send deficiency notices directly to the ultimate spouses in the small non-TEFRA shareholder partnerships. The S corporation itself would receive no deficiency notice unless it owed built-in gains tax under section 1374.

Ruling snapshot

• Question: What filing status and examination procedure applied if an LLC's corporate-classification election was unauthorized, compared with a valid S election?
• Outcome: Advice given on alternative outcomes: if the election was invalid, the LLC would be a TEFRA partnership; if it was valid, deficiency notices would generally go to the ultimate partners.
• Key authorities: IRC § 1374; Treas. Reg. § 301.7701-3(c)(2); TEFRA partnership procedures.

Full text (IRS public release)

ID: CCA-107129-08 Number: 200913043
Release Date: 3/27/2009
Office: --------------
UILC: 7701.01-00

From: -------------------
Sent: Tue 10/7/2008 1:29 PM
To: -------------------
Cc: ---------------------------------------------------------------------------------------------------------------------------
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Subject: RE: Invalid Check the box to be S Corp and also S Corp Election invalid, now partnership by default?

------says that the default would be to a partnership. First, 301.7701-3 (c)(2) says that the election must be filed by all members or by an officer authorized (under local law or entity's organizational docs) to make such an election. If the election wasn't authorized and thus is invalid, the LLC would default into partnership.

So if the election is a valid S corp election, we would issue notices of deficiency directly to the ultimate husband/wife partners in the shareholder partnerships. It appears that the husband/wife partnerships are not TEFRA since they would fall under the small partnership exception to TEFRA absent an affirmative election into TEFRA. No notice of deficiency would go to the entity electing S corp status unless they have a tax on built-in gain under section 1374.

If the election is invalid, the entity would be a TEFRA partnership since it has pass-through entities as partners (the husband/wife partnerships). We would issue an FPAA within 3 years of the date a partnership return is filed. --------------------------------------------------------------------------------------------------------
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