PLR 1032034: The IRS restored an S corporation election that ended when a shareholder became a nonresident alien

Plain-English summary

The IRS ruled that a corporation's S corporation election terminated when one of its shareholders became a nonresident alien. The termination was inadvertent because the corporation and its shareholders did not know that the change in the shareholder's status would end the election. After learning of the problem, the corporation redeemed the shareholder's stock and agreed to make any required adjustments. The IRS treated the corporation as continuing to be an S corporation from the termination date, subject to the stated conditions. The ruling also describes the shareholder reporting requirements for pass-through items, basis adjustments, distributions, and any gain from the stock redemption.

Ruling snapshot

• Question: Could the corporation continue to be treated as an S corporation after its election was inadvertently terminated by a nonresident alien shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, and 1368; IRC § 6110(k)(3).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201032034 Third Party Communication: None
Release Date: 8/13/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00 --------------------, ID No. -------------
Telephone Number:
---------------------
------------------------------ Refer Reply To:
-------------------------- CC:PSI:B02
----------------------------------------- PLR-154752-09
-------------------------- Date:
April 12, 2010

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

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

State = ------------------------------------
------------------------------------
a = -----------------

D1 = ------------------
D2 = ----------------------
D3 = ------------------------------------
D4 = ------------------------------------
Month = ------------------------------------
Year1 = ------------------------------------
Year2 = -------

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

This responds to a letter dated December 15, 2009, and subsequent correspondence,
submitted on behalf of X by its authorized representatives, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

FACTS

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.

PLR-154752-09 2

On D2, A, who was a resident alien, became a shareholder of X. On D3, A filed a Form
I-407, “Abandonment of Lawful Permanent Resident Status,” with the United States
Department of Homeland Security. Consequently, A became a nonresident alien, which
inadvertently terminated X’s S corporation election on D3. A did not realize that
becoming a nonresident alien would terminate X's S corporation election.

In Month, X learned of the consequences of A becoming a nonresident alien from its
external tax advisors. On D4, X redeemed A's shares in X with a payment of a. The
shares of X from D1 to D4 were owned by A and the other shareholders of X.

X represents that X did not intend for its S corporation election to terminate. X
represents that at no time prior to X’s external tax advisors informing X of the
consequences of A becoming a nonresident alien did X or any of its shareholders know
that A’s becoming a nonresident alien would terminate X’s S corporation status. X and
its shareholders have filed their tax returns for all applicable tax years consistent with X
being an S corporation.

A represents that A reported A’s share of X’s taxable income for Year1. A represents
that A will report and pay tax on A’s share of X’s taxable income for Year2 for the period
that A owned stock in X (through D4) when A files A’s U.S. individual income tax return
for Year2. A also represents that A will report and pay any U.S. federal income tax on
any gain recognized in connection with the payment of a in redemption of A’s ownership
interest received on D4.

X represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. X and its shareholders consent to make any adjustments (consistent with the
treatment of X as an S corporation) as may be required by the Secretary.

LAW AND ANALYSIS

Section 1361(a)(1) of the Code 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 the term “small business corporation” means a
domestic corporation which is not an ineligible corporation and which does not have a
nonresident alien as a shareholder.

Section 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall be
terminated whenever (at any time on or after the first day of the first taxable year for
which the corporation is an S corporation) such corporation ceases to be a small

PLR-154752-09 3

business corporation and (B) any termination under § 1362(d)(2) shall be 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 § 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.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on D3 and that the termination 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 D3 and thereafter,
provided X’s S corporation election was valid and provided that the election was not
otherwise terminated under § 1361(d). The shareholders of X, including A, must include
their pro-rata share of the separately stated and nonseparately computed items 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. In addition, A will report
and pay any U.S. federal income tax on any gain recognized in connection with the
payment of a in redemption of A's ownership interest received on D4. 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 no opinion concerning the federal tax
consequences of the transactions described above under any other provisions 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-154752-09 4

Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s
authorized representatives.

                                   Sincerely,



                                   Melissa C. Liquerman
                                   Chief, Branch 2
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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