PLR 201017009: Inadvertent S corporation termination disregarded

Plain-English summary

The IRS determined that an S corporation's termination was inadvertent after a shareholder became ineligible and later ceased to be an ineligible shareholder. The corporation did not intend to terminate its S election, the termination was not motivated by tax avoidance, and the corporation and its shareholders agreed to make any required adjustments. The IRS allowed the corporation to be treated as continuing to be an S corporation from the date the shareholder became ineligible, assuming the election was valid and was not otherwise terminated. The ruling did not address other federal tax consequences or whether the corporation was otherwise a valid S corporation.

Ruling snapshot

• Question: Could the corporation continue to be treated as an S corporation after an inadvertent termination caused by an ineligible shareholder?
• Outcome: approved
• Key authorities: IRC §§ 1361(a), 1361(b), and 1362(a), (d), and (f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201017009
Third Party Communication: None
Release Date: 4/30/2010
Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.03-02
Person To Contact:
---------------------------------------------------- ---------------, ID No. -------------
-------------------------------------
Telephone Number:
-------------
---------------------
------------------------------------
Refer Reply To:
--------------------------------
CC:PSI:B01
PLR-135317-09
Date:
January 21, 2010

Legend:

X = -------------------------------------------------------
---------------------------------------------------

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

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

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

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

Shareholder = ---------------------------------------------
--------------------------------------------------

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

This responds to a letter dated July 10, 2009, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS
PLR-135317-09
2

According to the information submitted, X was incorporated on Date 1 under the laws of State. X elected to be treated as an S corporation effective Date 1. On Date 2, Shareholder became an ineligible shareholder of X. On Date 3, Shareholder ceased to be an ineligible shareholder of X.

X represents that it did not intend for its S corporation election to terminate and the termination was not motivated by tax avoidance. Finally, X and its shareholders agree to make any adjustments required by the Secretary consistent with the treatment of X as an S corporation.

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 for the taxable year.

Section 1361(b)(1)(B) provides that a small business corporation cannot 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)(A) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the taxable year for which the corporation is an S corporation) the corporation ceases to be a small business corporation. The termination is effective on and after the day of cessation.
§ 1362(d)(2)(B).

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 consent, or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in the termination, steps were taken - (A) so that the corporation is a small business corporation, or (B) to acquire the required 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 this subsection, 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 such termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

CONCLUSION
PLR-135317-09
3

Based solely on the facts submitted and the representations made, we conclude that the termination of X=s S election constituted an “inadvertent termination@ within the meaning of § 1362(f).

Further, we conclude that, pursuant to § 1362(f), X will be treated as continuing to be an S corporation from Date 2 and thereafter, assuming X=s S election is valid and not otherwise terminated under § 1362(d).

Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of the above-described facts under any other provision of the Code, including whether X was otherwise a valid S corporation.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Sincerely,

David R. Haglund
David R. Haglund
Branch Chief, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)