PLR 1042003: IRS grants relief for disproportionate S-corporation distributions

Plain-English summary

The IRS considered a corporation that had made disproportionate distributions by failing to distribute amounts to one shareholder, even though its governing documents provided identical distribution and liquidation rights for all shares. The IRS concluded that the S election may have terminated because the corporation may have had more than one class of stock, but that any termination was inadvertent. The corporation could continue to be treated as an S corporation if its election was otherwise valid and not terminated for another reason. The relief was conditioned on three shareholders issuing repayment notes within 120 days and on the corporation filing consistent income tax returns. The ruling did not express an opinion on the validity of the loans or the corporation's general S-corporation eligibility.

Ruling snapshot

• Question: Can an S corporation receive relief after disproportionate distributions may have created a second class of stock?
• Outcome: Approved
• Key authorities: IRC §§ 1361(b), 1362(a), 1362(d), 1362(f), and 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201042003                                            Third Party Communication: None
Release Date: 10/22/2010                                     Date of Communication: Not Applicable
Index Number: 1361.01-04, 1362.00-00
                                                             Person To Contact:
---------------------------------                            -------------------, ID No. -------------
---------------------------------------------------------    Telephone Number:
----------------------------                                 ---------------------
--------------------------------                             Refer Reply To:
                                                             CC:PSI:B02
                                                             PLR-102529-10
                                                             Date:
                                                             July 08, 2010

X = ------------------------------------------------------------------------------------------------------------
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State = --------

A = ------------------------------------------------------------------------------------------------------------
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B = ------------------------------------------------------------------------------------------------------------
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C = ------------------------------------------------------------------------------------------------------------
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D = ------------------------------------------------------------------------------------------------------------
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Date = ----------------
1
Date = -------------------------
2
Date = -----------------------
3
Date = -----------------------
4
Year = -------

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

    This responds to a letter dated January 15, 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-102529-10 2

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

an election to be treated as an S corporation effective Date 2. X has had four shareholders,
A, B, C, and D, during the period at issue in this request. From Date 3 to Date 4, X made
disproportionate distributions to its shareholders by failing to make distributions to A. From
Date 3 to Date 4, X had only one class of common stock outstanding, with each share having
an identical right to distribution and liquidation proceeds. No provision in X’s articles of
incorporation or bylaws or other binding agreement altered that right.

   X represents that it did not intend to create a second class of stock or to terminate X’s

S corporation election and that the circumstances resulting in the possible termination of the
election were not motivated by tax avoidance or retroactive tax planning. X and its
shareholders consent to make such adjustments consistent with the treatment of X as an S
corporation as may be required by the Secretary. X represents that it will make necessary
adjustments to rectify the disproportionate distributions made from Date 3 to Date 4.
Additionally, B, C, and D agree to treat these disproportionate distributions as loans and to
repay these amounts plus accrued interest to X.

    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 facts submitted and the representations made, we conclude that

X's S corporation election may have terminated on Date 3 because X may have had more
than one class of stock. However, we conclude that, if X's S election was terminated, such a
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
Date 3 and thereafter, provided X’s S corporation election was valid and provided that the
election was not otherwise terminated under § 1362(d). This ruling is contingent upon B, C,
and D issuing to X, within 120 days of this letter, notes for the repayment of the
disproportionate distributions. This ruling is further contingent upon X filing income tax
returns for Year and thereafter consistent with this ruling.
PLR-102529-10 3

   Except as specifically set forth above, no opinion is expressed concerning the federal

tax consequences of the facts described above under any provision of the Code.
Specifically, no opinion is expressed, for federal tax purposes, regarding X’s eligibility to be
an S corporation nor the validity of the loans from B, C, and D to X.

  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

cc: