PLR 201027001: Inadvertent S corporation termination from a nonresident-alien shareholder

Plain-English summary

The IRS ruled that a corporation's S corporation election terminated when it issued stock to a nonresident alien, who was an ineligible S corporation shareholder. The corporation promptly redeemed the shares and continued treating itself as an S corporation. The IRS found the termination inadvertent and allowed the corporation to continue its S corporation status, provided the election was otherwise valid and not otherwise terminated. The ruling required the eligible shareholders to report the corporation's items and make any required basis and distribution adjustments, and it required any amended returns to be filed within 60 days.

Ruling snapshot

• Question: Could the corporation receive relief from an inadvertent S corporation termination caused by issuing stock to a nonresident alien?
• Outcome: approved, subject to the stated shareholder reporting and amended-return conditions
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368; IRC § 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201027001
Third Party Communication: None
Release Date: 7/9/2010
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:B02
PLR-100379-10
Date:
March 16, 2010

Legend

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

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

State = --------------
Date 1 = ---------------------------------
Date 2 = ----------------------

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

Date 4 = --------------------------------
Dear ---------------:

This letter responds to a letter dated December 29, 2009, submitted by X's authorized representative on behalf of X, requesting inadvertent termination relief under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was formed under the laws of State on Date 1 and elected to be treated as an S corporation effective Date 1. Effective Date 2, X issued shares of X to A, a non-resident alien and an ineligible S corporation shareholder under § 1361(b)(1)(C). X represents that upon discovery of its error, it promptly took remedial action. Effective Date 4, X redeemed all of the shares it had issued to A.

X represents that the transfer X of stock to A, an ineligible shareholder, was not motivated by tax avoidance or retroactive tax planning. X and its shareholders have continued to treat X as an S corporation at all times. X and its shareholders agree to
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make any adjustments (consistent with the treatment of X as an S corporation) that the Secretary may require.

Section 1361(a)(1) of the Code defines an “S corporation” as a small business corporation for which an election under § 1362(a) is in effect for such year.

Section 1361(b)(1)(C) provides that a domestic corporation cannot be a “small business corporation” if the corporation has a non-resident alien as a shareholder.

Section 1362(d)(2) 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 a corporation is an S corporation) such corporation ceases to be a small business corporation. A termination of an S corporation election under § 1362(d)(2) is effective on and after the date of cessation.

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 paragraph (2) or (3) of § 1362(d), (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 such ineffectiveness or 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 § 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 such ineffectiveness or termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.

Based solely on the information submitted and the representations made, we conclude that X's S corporation election terminated on Date 2, when X issued X stock to A, an ineligible shareholder. We also conclude that this termination was inadvertent within the meaning of § 1362(f), and that under the provisions of § 1362(f), X will be treated as an S corporation from Date 2, and thereafter, provided that X's S election was valid and was not otherwise terminated.

This ruling is conditioned on the following. For any tax periods during the period beginning on Date 3 and ending on Date 4 in which X reported a net gain, X’s eligible shareholders, pro rata, will be treated as the shareholders of the shares held by A. All of X's eligible shareholders, in determining their respective income tax liabilities during the termination period and thereafter, must include their pro rata share of the separately stated items of income (including tax-exempt income), loss, deduction, or credit and
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non-separately stated computed items of income or loss of X as provided in § 1366, make any adjustments to basis as provided in § 1367, and take into account any distributions made by X as provided in § 1368. Any amended returns must be filed with the appropriate service center within 60 days of the date of this letter. A copy of this letter should be attached to the amended returns. If X or X’s eligible shareholders fail to comply with these conditions, this ruling shall be null and void.

Except as specifically ruled upon above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code. Specifically, no opinion is expressed on whether X was otherwise eligible to be treated as an 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.

Pursuant to the power of attorney on file with this office, a copy of this letter is being sent to X's authorized representative.

Sincerely,

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

Enclosures: (2)

Copy of this letter

Copy for § 6110 purposes