PLR 1026006: IRS upheld an S corporation election after a void stock transfer

Plain-English summary

The IRS concluded that a corporation's S corporation election did not terminate when a shareholder attempted to transfer stock to an ineligible shareholder. A court had determined that the transfer was void from the beginning under state law, so the recipient was never a shareholder and the original shareholder remained the legal owner. The corporation and its shareholders were required to treat the corporation as continuously holding S corporation status, amend inconsistent returns, and file the amended returns within 60 days of the ruling. The IRS did not rule on whether the corporation otherwise qualified as a small business corporation under IRC § 1361(b).

Ruling snapshot

• Question: Did an attempted transfer of stock to an ineligible shareholder terminate the corporation's S corporation election when a court later declared the transfer void?
• Outcome: approved
• Key authorities: IRC §§ 1361 and 1362; IRC § 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201026006 Third Party Communication: None
Release Date: 7/2/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.02-00 ------------------, ID No. -------------
Telephone Number:
-------------------------------- Refer Reply To:
---------------------------- CC:PSI:B02
------------------------ PLR-101803-10
------------------- Date:
----------------------------- January 22, 2010

LEGEND

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

A = ----------------------------------

B = ------------------------------------------------------------------------------------------

                        -------------------------------

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

Court = ---------------------------------------------------------------

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

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

D3 = --------------------------

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

This responds to a letter dated January 8, 2010 submitted on behalf of X by its
authorized representative, requesting a ruling that X's subchapter S election did not
terminate on D2.

The information submitted states that X was incorporated in State on D1. X made an
election to be treated as an S corporation effective D1. As part of X’s formation, X’s
founding shareholders, which included A, executed a Shareholders’ Agreement. Under
this agreement, a shareholder desiring to transfer shares of X must (i) obtain the
PLR-101803-10 2

consent of the other shareholders prior to transfer, (ii) the transferee must become a
party to the agreement, and (iii) no transfer is allowed if the transfer would result in the
termination of X’s S corporation status.

On D2, A attempted to transfer a portion of his shares in X to B, which is not an eligible
S corporation shareholder. On D3, Court entered an order holding that the attempted
transfer of A's shares in X to B was null and void and that A remained the record and
legal owner of all of the shares A attempted to transfer to B.

Section 1362(a) of the Internal Revenue Code 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.

Sections 1362(d)(2)(A) provides that an S election terminates 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 corporation.

Based solely on the facts and representations submitted, because A's transfer of X
shares to B was void ab initio under State law as determined by Court, we conclude that
X's S corporation election did not terminate on D2. Accordingly, as B was never a
shareholder of X, X will be treated as continuing to be an S corporation from D2, and
thereafter, provided X's S corporation election was valid, and has not otherwise
terminated under the provisions of § 1362(d).

X and all its current and prior shareholders must treat X as having been an S
corporation for the period from D2 to the present. In addition, X and its shareholders
must treat A as having been the shareholder of the X shares which A attempted to
transfer to B and amend any prior tax returns that are inconsistent with this treatment.
Any amended returns required under this paragraph must be filed within 60 days of the
date of this ruling or it will be null and void. A copy of this letter must be attached to any
such returns.

Except as specifically set forth above, no opinion is expressed concerning the federal
tax consequences of the facts described above under any other provision of the Code,
including whether X was or is a small business corporation under § 1361(b) of the
Code.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.
PLR-101803-10 3

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