PLR 200952016: An inadvertent S corporation termination was given retroactive relief

Plain-English summary

The IRS treated a corporation as continuing to be an S corporation after its election had terminated because shares were transferred to an ineligible shareholder. The corporation corrected the problem after discovering it and represented that there was no tax avoidance and that its reporting had remained consistent with S corporation treatment. The IRS found the termination inadvertent under IRC section 1362(f), subject to the election otherwise being valid and not otherwise terminated. The shareholders also had to report pass-through items and distributions consistently, or the ruling would be void.

Ruling snapshot

• Question: Could a corporation receive relief after its S corporation election terminated because of an ineligible shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1361(a), 1361(b)(1)(B), 1362(a), 1362(d)(2), and 1362(f); §§ 1366 through 1368

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200952016
Third Party Communication: None
Release Date: 12/24/2009
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:
CC:PSI:B01
PLR-119175-09
Date: September 24, 2009

Legend

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

m = ---

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

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

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

Date 4 = -------

Date 5 = ---------------------

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

This responds to a letter dated March 30, 2009, and subsequent correspondence, submitted on behalf of X by X’s authorized representative, requesting
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inadvertent S corporation election termination relief pursuant to § 1362(f) of the Internal Revenue Code.

Facts

X was incorporated under the laws of State on Date 1, and elected to be treated as an S corporation effective Date 2.

On Date 3, m shareholders of X transferred certain shares of X to A. A is not an eligible shareholder of an S corporation under § 1361(b)(1)(B). Neither X nor X's shareholders were aware that the transfer of stock to A would cause X's S corporation election to be terminated.

In Date 4, X learned of the termination of X's S corporation election due to the transfer of stock to an ineligible shareholder. In order to correct this, in Date 4, A distributed the shares of X to the m shareholders that had contributed the shares to A, effective Date 5.

X represents that there was no tax avoidance involved in the inadvertent termination. X represents that the m shareholders of X have reported all of the income from X on the shareholders’ individual federal income tax returns since Date 3. In addition, X represents that X and each of the m shareholders of X have filed their income tax returns consistent with the treatment of X as an S corporation since Date 3.

Law

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

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)(B) provides that, for purposes of subchapter S, the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which does not 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.

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

Section 1362(f) provides, in part, that if -- (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2); (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 such termination, steps were taken so that the corporation for which the termination occurred is a small business corporation, or to acquire the required shareholder consents; 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 specified pursuant to § 1362(f), agrees to make such adjustments (consistent with the treatment of such corporation as an S corporation) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in such termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

Conclusion

Based solely on the information submitted and the representations made, we conclude that X's S corporation election was terminated for the taxable year beginning Date 3 because A was an ineligible shareholder. We further conclude that the termination of X’s S corporation election constituted an inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date 3 and thereafter, provided that X's S corporation election was otherwise valid and has not otherwise terminated under § 1362(d).

From Date 3 to Date 5, the m former members of A must be treated as directly owning a pro rata portion of the shares of X that were held by A, in addition to any other shares in X that they held during such period.

All shareholders of X must include the pro rata share of the separately and nonseparately computed items of X as provided in § 1366, make adjustments to basis as provided in § 1367, and take into account any distributions as provided in § 1368. If X or its shareholders fail to treat themselves as described above, this ruling is null and void.

Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the transactions described above under any other provision of the Code. Specifically, we express or imply no opinion regarding X‘s eligibility to be 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 a power of attorney on file with this office, a copy of this letter is being sent to X's authorized representative.

Sincerely,

Faith P. Colson

Faith P. Colson
Senior Counsel, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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