PLR 1037004: IRS restored an S corporation election after an impermissible shareholder acquisition

Plain-English summary

The IRS ruled that a corporation's S election terminated when a C corporation acquired its stock and became an impermissible shareholder. The IRS also found that the termination was inadvertent because the corporation did not know of the shareholder's status, corrected the problem after discovering it, and represented that the circumstances were not tax-motivated. The corporation was treated as continuing to be an S corporation from the acquisition date through the corrective sale and afterward, assuming the election was otherwise valid and was not otherwise terminated. The ruling does not decide whether the corporation otherwise qualified as an S corporation.

Ruling snapshot

• Question: Could the corporation receive relief after an impermissible shareholder caused its S election to terminate?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201037004 Third Party Communication: None
Release Date: 9/17/2010 Date of Communication: Not Applicable
Index Number: 1362.00-00
Person To Contact:
------------------------------------ -------------------, ID No. -------------
---------------------- Telephone Number:
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-------------- Refer Reply To:
---------------------------- CC:PSI:B02
PLR-105078-10
Date:
June 11, 2010

X = -----------------------------------------------------------------------------------------------------
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Y = -----------------------------------------------------------------------------------------------------
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A = -----------------------------------------------------------------------------------------------------
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State = ----------

Date = ------------------
1
Date = ---------------------
2
Date = ----------------------
3
Year = -------

n = 3

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

   This responds to a letter dated January 20, 2010, and subsequent

correspondence, submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code.
PLR-105078-10 2

    The information submitted states that X was incorporated in State on Date 1. X

filed an election to be treated as an S corporation under § 1362 for its taxable year
beginning Date 1. On Date 2, Y acquired n% of X stock. X was unaware that Y, a C
corporation, was an impermissible S corporation shareholder. In Year, X discovered
that Y was an impermissible shareholder. On Date 3, Y sold its entire interest in X to A,
an eligible shareholder. X and its shareholders then requested inadvertent invalid
election relief under § 1362(f) of the Code.

   X represents that the circumstances resulting in the termination of X’s S

corporation election were inadvertent and not motivated by tax avoidance. X further
represents that from Date 2, X and its shareholders have filed all returns consistent with
X’s status as an S corporation. X and its shareholders have agreed to make such
adjustments consistent with the treatment of X as an S corporation as may be required
by the Secretary.

    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 information submitted and the representations made, we

conclude that Y’s acquisition of X stock on Date 2 terminated X’s S election. We also
conclude that the termination of X’s S election was inadvertent within the meaning of
§ 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as
continuing to be an S corporation from Date 2 to Date 3 and thereafter, provided X’s S
election was valid and was not otherwise terminated under § 1362(d).

   Except as specifically set forth above, we express no opinion concerning the

federal tax consequences of the above-described facts under any other provision of the
Code. Specifically, no opinion is expressed on whether X is otherwise eligible to be
treated as an S corporation.
PLR-105078-10 3

   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.

  In accordance with the power of attorney on file with this office, we are sending a

copy of this letter to X’s authorized representative.

                                  Sincerely,



                                  Richard T. Probst
                                  Branch Reviewer, Branch 2
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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