PLR 200953016: Inadvertent S corporation termination disregarded under section 1362(f)

Plain-English summary

An entity asked the IRS to address the inadvertent termination of its S corporation election after a partnership became the owner of its stock. The partnership later changed its federal tax classification to an entity disregarded from its owner. The IRS concluded that the termination was inadvertent and that the entity would continue to be treated as an S corporation, provided its original election was valid and was not otherwise terminated. The ruling required the corporation and shareholders to report items, adjust basis, and account for distributions consistently with S corporation treatment. The ruling did not address other federal tax consequences.

Ruling snapshot

• Question: Could an entity continue to be treated as an S corporation after its election was inadvertently terminated by an ownership change?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200953016
Third Party Communication: None
Release Date: 12/31/2009
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:B02
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Date:
September 23, 2009

LEGEND

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

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

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

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

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

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

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

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

This responds to a letter dated September 15, 2009, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated in State on Date 1. X made an election to be treated as an S corporation effective Date 1. X’s election was inadvertently terminated effective Date 2 when Y, a partnership for federal income tax purposes owned by a and b, became the owner of X stock. On Date 3, a and b entered into an agreement to transfer the ownership of Y to a which resulted in Y’s federal tax classification changing from a partnership to an entity disregarded from its owner, a.
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X represents that the termination was not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make any adjustments that the Commissioner may require, consistent with the treatment of X as an S corporation.

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), (2) the Secretary determines that the circumstances resulting in the ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in the ineffectiveness or termination, steps were taken (A) so that the corporation is a small business corporation or (B) to acquire the shareholder consents, and (4) the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to § 1362(f), agrees to make 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 ineffectiveness or termination, the corporation will be treated as an S corporation during the period specified by the Secretary.

Based solely on the facts submitted and the representations made, we conclude that the termination of X’s S corporation election on Date 1 was inadvertent within the meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 1 and thereafter, provided X’s S corporation election was valid and provided that the election was not otherwise terminated under § 1361(d).

This ruling is conditioned upon the shareholders of X including in income their pro rata share of the separately stated and nonseparately computed items of X as provided in § 1366, making any adjustments to basis as provided in § 1367, and taking into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat themselves as described above, this letter ruling shall be null and void.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code. Specifically, we express no opinion as to the consequences of the proposed transactions under the estate and gift tax provisions of chapters 11 and 12 of subtitle B, including the proper valuation of any property or interest in property for federal estate and gift tax purposes.

This ruling is directed only to the taxpayer that requested it. Section 6110(j)(3) provides that it may not be used or cited as precedent.
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Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s authorized representatives.

Sincerely,

Bradford R. Poston
Senior Counsel, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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