PLR 1045002: Inadvertent S corporation termination was corrected after an ineligible shareholder transfer

Plain-English summary

The IRS ruled that an S corporation's election had terminated when shares were transferred to an ineligible trust. Because the transfer was inadvertent, the IRS allowed the corporation to continue being treated as an S corporation under IRC § 1362(f), subject to filing amended returns, making a required payment, and applying other specified adjustments. The shareholders also had to report the corporation's income and distributions consistently with S corporation treatment. The ruling became void if its conditions were not met.

Ruling snapshot

• Question: May the corporation continue to be treated as an S corporation after its election terminated because of an inadvertent transfer to an ineligible shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368; Treas. Reg. § 1.1362-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201045002 Third Party Communication: None
Release Date: 11/12/2010 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------------------------------- ---------------------, ID No. -----------------
---------------------------------- Telephone Number:
----------------------------- -------------------
---------------------------------------- Refer Reply To:
CC:PSI:B03
PLR-105441-10
Date:
July 20, 2010

                                                  LEGEND

X = -----------------------------------------------------------------------------------------------------
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Trust = -----------------------------------------------------------------------------------------------------
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A = -----------------------------------------------------------------------------------------------------
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B = -----------------------------------------------------------------------------------------------------
--------------------------

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

Date = -----------------
1
Date = ----------------------
2
Date = ---------------------------
3
Date = ------------------------
4
Date = --------------------------
5
Year = -------
1
Year = -------
2
Year = -------
PLR-105441-10 2

3
n = ---------------
Dear ------------------:

   This letter responds to your letter dated January 27, 2010, and subsequent

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

                                      FACTS

   X was incorporated under the laws of State on Date 1. X elected to be an S

corporation effective Date 2. On Date 3, A and B transferred shares of X’s stock to
Trust. Trust was not a trust identified in § 1362(c)(2); therefore, Trust was an ineligible
shareholder and X’s S corporation election terminated on Date 3.

   X represents that there was no intent to terminate X’s S corporation election and

that the transfer to Trust was inadvertent and not motivated by tax avoidance or
retroactive tax planning. After Trust was informed of its status as an ineligible
shareholder, the trustee of Trust on Date 4 distributed the stock to A. For all taxable
years, X and X’s shareholders reported income consistent with X qualifying as an S
corporation. In addition, X and X’s shareholders agree to make any adjustments
consistent with the treatment of X as an S corporation as may be required by the
Secretary with respect to the period specified by § 1362(f).

                              LAW AND ANALYSIS

    Section 1361(a)(1) 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) defines a “small business corporation” as a domestic

corporation which is not an ineligible shareholder and which does not (A) have more
than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more than 1
class of stock.

   Section 1362(d)(2)(A) 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
corporation.

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

by any corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary
PLR-105441-10 3

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; and (4) the corporation for which the
termination occurred, and each person who was a shareholder of the corporation at any
time during the period specified pursuant to § 1362(f), agrees to make the adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to this period, then, notwithstanding the
circumstances resulting in the termination, the corporation shall be treated as an S
corporation during the period specified by the Secretary.

  Section 1.1362-4(d) of the Income Tax Regulations provides that the

Commissioner may require any adjustments that are appropriate. In general, the
adjustments required should be consistent with the treatment of the corporation as an S
corporation during the period specified by the Commissioner.

                                  CONCLUSION

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

X’s S corporation election was terminated on Date 3 when X’s stock was contributed to
Trust because Trust was an ineligible shareholder. We further conclude that the
termination was inadvertent within the meaning of § 1362(f). Pursuant to the provisions
of § 1362(f), X will be treated as continuing to be an S corporation on and after Date 3,
unless X’s S corporation election is otherwise terminated under § 1362(d) and provided
that the following conditions are met. From Date 3, A will be treated as directly holding
the shares of X held by Trust. A must file within 120 days of this ruling any amended
returns for Years 1, 2, and 3 as necessary to treat A as the owner of the X stock held by
Trust. As an adjustment under § 1362(f)(4), A must send a payment of $n and a copy
of this letter to the following address: Internal Revenue Service, Cincinnati Service
Center, 201 West Rivercenter Blvd., Covington, KY 41011, Stop 31, Terri Lackey,
Manual Deposit. This payment must be sent no later than Date 5.

    This ruling is contingent upon X and all its shareholders treating X as having

been an S corporation for the period beginning on Date 3, and thereafter. The
shareholders of X must include in their income their pro rata share of 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. This ruling is contingent upon X and each of its shareholders filing
any amended returns and making such adjustments that are necessary to properly
reflect the reporting of X’s items of S corporation income.

  A copy of this letter must be attached to any income tax return to which it is

relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
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requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.

    If all of the above conditions are not met, then this ruling is null and void.

Furthermore, if these conditions are not met, X must notify the Cincinnati Service Center
that its S corporation election has terminated.

     Except for the specific ruling above, no opinion is expressed or implied

concerning the federal tax consequences of the facts of this case under any other
provision of the Code. Specifically, no opinion is expressed or implied regarding X’s
eligibility to be an S corporation.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

  This ruling is directed only to the taxpayer who requested it. According to

§ 6110(k)(3), this ruling may not be used or cited as precedent.

    Under a power of attorney on file with this office, we are sending a copy of this

letter to your authorized representative.

                                   Sincerely,

                                   /s/

                                   James A. Quinn
                                   Senior Counsel, Branch 3
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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