PLR 1046005: S corporation status preserved after transfer to an ineligible shareholder

Plain-English summary

The IRS ruled that a corporation's S corporation election terminated when it inadvertently issued shares to an IRA, which was an ineligible shareholder. The corporation promptly redeemed the shares after discovering the error and represented that the transfer was not motivated by tax avoidance or retroactive planning. The IRS determined that the termination was inadvertent and allowed the corporation to continue to be treated as an S corporation from the transfer date, subject to the stated conditions. Those conditions included special shareholder treatment during the termination period and pass-through reporting under sections 1366, 1367, and 1368. The ruling would be void if the corporation or its shareholders failed to follow those conditions.

Ruling snapshot

• Question: Can the corporation retain S corporation treatment after inadvertently issuing shares to an ineligible IRA shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1361(a)(1), 1361(b)(1)(B), 1362(a), 1362(d)(2), and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201046005 Third Party Communication: None
Release Date: 11/19/2010 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------ -------------------, ID No. -------------
------------------------- Telephone Number:
------------------------- ---------------------
-------------------------------- Refer Reply To:
CC:PSI:B02
PLR-112246-10
Date:
July 20, 2010

Legend

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

IRA = -------------------------------------------------------------------------------
--------------------

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

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

Year 1 = ---------------------

Date 1 = ----------------

Date 2 = --------------------

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

   This letter responds to a letter dated March 17, 2010, submitted by X's

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

   The information submitted states that X’s predecessor was formed under the

laws of State and elected to be treated as an S corporation in Year 1. Effective Date 1,
X inadvertently issued shares of X to IRA, an ineligible shareholder under
§ 1361(c)(1)(A). X represents that upon discovery of its error, it promptly took remedial
action. Effective Date 2, X redeemed all of the shares it had transferred to IRA.
PLR-112246-10 2

   X represents that the transfer X of stock to IRA, an ineligible shareholder, was

not motivated by tax avoidance or retroactive tax planning. X and its shareholders have
continued to treat X as an S corporation at all times. X and its shareholders agree to
make any adjustments (consistent with the treatment of X as an S corporation) that the
Secretary may require.

  Section 1361(a)(1) of the Code defines an “S corporation” as a small business

corporation for which an election under § 1362(a) is in effect for such year.

   Section 1361(b)(1)(B) provides that a “small business corporation” cannot have

as a shareholder a person (other than an estate and other than a trust described in
§ 1361(c)(2) or an organization described in § 1361(c)(6)) who is not an individual.

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

whenever (at any time on or after the first day of the taxable year for which a
corporation is an S corporation) such corporation ceases to be a small business
corporation. A termination of an S corporation election under § 1362(d)(2) is effective on
and after the date of cessation.

    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 paragraph (2)
or (3) of § 1362(d), (2) the Secretary determines that the circumstances resulting in
such ineffectiveness or termination were inadvertent, (3) no later than a reasonable
period of time after discovery of the circumstances resulting in such ineffectiveness or
termination, steps were taken (A) so that the corporation is a small business
corporation, or (B) to acquire the required 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 such ineffectiveness or termination, the corporation shall 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 terminated effective Date 1, the effective date
of X’s transfer of X stock to IRA, an ineligible shareholder. We also conclude that this
termination was inadvertent within the meaning of § 1362(f), and that under the
provisions of § 1362(f), X will be treated as an S corporation from Date 1, and
thereafter, provided that X's S election was valid and was not otherwise terminated.

  As a condition for this ruling, for any tax periods from Date 1 to Date 2, in which

X reported a net loss, IRA will be treated as the shareholder of the shares of stock at
PLR-112246-10 3

issue. Otherwise, X’s shareholders, on a pro rata basis, will be treated as the
shareholder of the shares for the tax periods from Date 1 to Date 2. All of X's
shareholders, in determining their respective income tax liabilities during the termination
period and thereafter, must include their pro rata share of the separately stated items of
income (including tax-exempt income), loss, deduction, or credit and non-separately
stated computed items of income or loss of X as provided in § 1366, make any
adjustments to basis provided in § 1367, and take into account any distributions made
by X as provided in § 1368. If X or its shareholders fail to treat themselves as described
above, this ruling shall be null and void.

   Except as specifically ruled upon above, we express no opinion concerning the

federal tax consequences of the transactions described above under any other
provisions of the Code. Specifically, no opinion is expressed on whether X was
otherwise eligible to be treated as an S corporation.

   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.

   Pursuant to the power of attorney on file with this office, a copy of this letter is

being sent to X's authorized representative.

                                               Sincerely,



                                               Charlotte Chyr
                                               Senior Technician Reviewer, Branch 2
                                               Office of the Associate Chief Counsel
                                               (Passthroughs and Special Industries)

Enclosures: (2)

Copy of this letter
Copy for § 6110 purposes

cc: