PLR 1040001: Inadvertent S corporation termination relief

Plain-English summary

The IRS ruled that a corporation's S corporation election terminated when a shareholder became a nonresident alien and therefore became an ineligible shareholder. Because the termination was inadvertent, the corporation qualified for relief under IRC § 1362(f) and would continue to be treated as an S corporation from the termination date, assuming its election was otherwise valid. The former shareholders were required to be treated as directly owning the transferred shares during the affected period, and the shareholders had to report the corporation's items and distributions consistently with S corporation treatment. The ruling would be null and void if the corporation or its shareholders failed to follow those conditions.

Ruling snapshot

• Question: Was the corporation's S corporation election termination inadvertent and eligible for relief under section 1362(f)?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201040001 Third Party Communication: None
Release Date: 10/8/2010 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
---------------------------------------------- --------------------, ID No. -----------------
----------------------------------------- Telephone Number:
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------------------------------------------ Refer Reply To:
CC:PSI:B01
PLR-105452-10
Date:
July 08, 2010

LEGEND

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

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

State = --------

p = -----

d1 = ---------------------

d2 = ----------------------

d3 = ----------------------

d4 = ----------------------

d5 = --------------------------

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

PLR-105452-10 2

  This letter responds to a letter, dated January 29, 2010, and subsequent

correspondence, on behalf of X from X's authorized representative, requesting
inadvertent termination relief under §1362(f) of the Internal Revenue Code.

FACTS

   According to the information submitted, X was incorporated under the laws of

State on d1, and elected to be treated as an S corporation effective d2. In d3,
shareholders of X transferred p shares of X stock to A. Prior to d4, A was a resident
alien. However, in d4, A‘s status as a resident alien was revoked, causing A to become
a nonresident alien. The change in A‘s status caused X’s status as an S corporation to
terminate. A and the other shareholders of X did not intend to terminate X’s status as an
S corporation. X represents that the transfer of shares to A was not motivated by tax
avoidance, and neither X nor its shareholders intended to obtain, nor did obtain, a tax
benefit by having A as a shareholder.

   On d5, X reacquired all the shares transferred to A. In addition, on d5, X and A

entered into an agreement that A would not be treated as a shareholder of X from d3
through d5. X did not allocate any income, gain, loss, or deductions to A. X and each
person that was a shareholder of X subsequent to d3 filed their United States income
tax returns in a manner consistent with the treatment of X as an S corporation. X, A,
and each shareholder of X agree to make any adjustments consistent with the treatment
of X as an S corporation that the Secretary may require.

  X requests a ruling that the termination of its S corporation election was

inadvertent within the meaning of §1362(f).

LAW AND ANALYSIS

    Section 1361(a) 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, in part, that the term "small business

corporation" means a domestic corporation which is not an ineligible corporation and
which does not 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(a) provides that, except as provided in §1362(g), a small business

corporation may elect to be an S corporation.

  Section 1362(d)(2) provides that an election under § 1362(a) shall be terminated

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

PLR-105452-10 3

corporation, and that any termination under § 1362(d)(2) shall be effective on and after
the date of cessation.

   Section 1362(f) provides, in part, that if -- (1) an election under § 1362(a) by any

corporation was terminated under § 1362(d)(2); (2) the Secretary determines that the
circumstances resulting in such termination were inadvertent; (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, or to acquire the required shareholder consents; and (4)
the corporation for which the termination occurred, and each person who was a
shareholder in such corporation at any time during the period specified pursuant to
§ 1362(f), agrees to make such adjustments (consistent with the treatment of such
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

   Based solely on the facts submitted and representations made, we conclude that

X's S corporation election was terminated in d4 because A was an ineligible shareholder
of X. We further conclude that the termination of X's S corporation election constituted
an inadvertent termination within the meaning of §1362(f). Under the provisions of
§1362(f), X will be treated as an S corporation from d4, and thereafter, provided that,
apart from the inadvertent termination described above, X's S corporation election was
otherwise valid and has not otherwise terminated under §1362(d).

    From d3 to d5, the shareholders of X that transferred shares to A must be treated

as directly owning the shares of X that were transferred to A, in addition to any other
shares in X that they held during such period. All shareholders of X must include the pro
rata share of the separately and nonseparately computed items of X as provided in
§ 1366, make adjustments to basis as provided in § 1367, and take into account any
distributions as provided in § 1368. 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 or imply no opinion concerning

the federal tax consequences of the transactions described above under any other
provision of the Code. Specifically, except as specifically ruled above, we express or
imply no opinion regarding X‘s eligibility to be an S corporation.

PLR-105452-10 4

  This ruling is directed only to the taxpayer requesting 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
                                  Chief, Branch 1
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

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