PLR 1042014: IRS grants relief for a possible second class of stock

Plain-English summary

The IRS considered a corporation's request for relief after a stock purchase agreement gave a trust the right to receive up to the full value of its initial investment if a sale of the corporation resulted in a loss. The IRS concluded that this clause may have created more than one class of stock and may have terminated the corporation's S election. It further concluded that any termination was inadvertent under IRC § 1362(f), because the clause was removed, no payment was made under it, and the corporation and shareholders represented that they acted consistently with S status. The corporation was treated as continuing to be an S corporation from the specified date, provided its election was otherwise valid and was not terminated for another reason.

Ruling snapshot

• Question: Can an S corporation receive relief when a stock agreement may have created a second class of stock?
• Outcome: Approved
• Key authorities: IRC §§ 1361(b), 1362(a), 1362(d)(2), 1362(d)(3), 1362(f), and 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201042014 Third Party Communication: None
Release Date: 10/22/2010 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------ -------------------, ID No. -------------
------------------------ Telephone Number:
--------------------------------------- ---------------------
--------------------------------- Refer Reply To:
CC:PSI:B02
PLR-111838-10
Date:
July 09, 2010

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

State = -------------

Date = --------------------------
1
Date = ----------------------
2
Date = -------------------
3
=
Date = -----------------------
4
Trust = -----------------------------------------------------------------------------------------------------
-----------------------

n = -----

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.

    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 2. On or about Date 3, X sold n shares of its stock to Trust, an eligible
PLR-111838-10 2

S corporation shareholder. Pursuant to the purchase agreement, the n shares were of
the same share class and had the same rights and titles as the remaining outstanding
shares. However, the purchase agreement contained a clause that allowed Trust to
receive up to the full value of its initial investment in the event a sale of X resulted in a
loss. On Date 4, X and Trust amended the purchase agreement to remove this clause
and eliminate any second class of stock. No payment was ever made under the clause.
X and its shareholders then requested inadvertent invalid election relief under § 1362(f).

   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 X's S corporation election may have terminated 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).
Accordingly, 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 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-111838-10 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,



                                  Bradford R. Poston
                                  Acting Chief, Branch 2
                                  Office of Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: