PLR 200944018: Inadvertent S corporation termination relief after disproportionate distributions

Plain-English summary

The IRS considered whether a corporation's disproportionate shareholder distributions may have terminated its S corporation election by creating a second class of stock. The corporation discovered that it had failed to make distributions to some shareholders and corrected the situation with corrective distributions. The IRS ruled that any termination was inadvertent and that the corrective action did not create a second class of stock, so the corporation would continue to be treated as an S corporation from the stated date, assuming its election was not otherwise terminated. The ruling was based on the submitted facts and representations and did not address the corporation's general S corporation qualification.

Ruling snapshot

• Question: Did the corporation's disproportionate distributions terminate its S corporation election, and if so, can inadvertent termination relief apply?
• Outcome: Approved
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200944018
Third Party Communication: None
Release Date: 10/30/2009
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:
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CC:PSI:B01
PLR-121667-09
Date:
July 24, 2009

Legend:

X = -----------------
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State = --------------------

D1 = -----------------------

D2 = ---------------------------

Y1 = -------

Y2 = -------

a = --

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

This responds to the letter dated April 21, 2009, submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue Code.

Facts

According to the information submitted, X is a corporation formed on D1 pursuant to the laws of State. X made an election to be treated as an S corporation on D2. In year Y1, X made disproportionate distributions to its shareholders by failing to make distributions to a of its shareholders. X discovered this in year Y2, and has rectified the situation by making the necessary corrective distributions.
PLR-121667-09
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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 which does not (A) have more than 100 shareholders, (B) have as a shareholder a person (other than an estate, and 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.

Section 1.1361-1(l)(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(l)(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). A commercial contractual agreement, such as a lease, employment agreement, or loan agreement, is not a binding agreement relating to distribution and liquidation proceeds and thus is not a governing provision unless a principal purpose of the agreement is to circumvent the one class of stock requirement. 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)(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
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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 representation 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 a termination was inadvertent within the meaning of § 1362(f) of the Code. Further, we conclude that the corrective action taken by X and the shareholders for Y1 does not create a second class of stock under § 1361. Consequently, we rule that X will be treated as continuing to be an S corporation from D2, and thereafter, provided that X’s S election otherwise is not terminated under § 1362(d).

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 requesting 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 will be sent to X’s authorized representative.

Sincerely,

David R. Haglund

David R. Haglund
Senior Technician Reviewer, Branch 1
Office of Associate Chief Counsel
(Passthroughs and Special Industries)
Enclosures (2):
Copy of this letter,
Copy for § 6110 purposes