PLR 1050025: Inadvertent S corporation termination disregarded

Plain-English summary

The IRS ruled that a corporation’s S corporation election was inadvertently terminated when two ineligible shareholders acquired stock. The shareholders later redeemed their interests, leaving the original shareholder as the sole shareholder, and the corporation represented that the termination was not motivated by tax avoidance or retroactive planning. Under IRC § 1362(f), the IRS treated the corporation as continuing to be an S corporation, subject to the election having originally been valid and not otherwise terminated. The ruling also required the corporation and its shareholders to report income, adjust basis, account for distributions, and make any other required adjustments consistent with S corporation treatment.

Ruling snapshot

• Question: Could the corporation continue to be treated as an S corporation after an inadvertent termination caused by ineligible shareholders?
• 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: 201050025 Third Party Communication: None
Release Date: 12/17/2010 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:B02
PLR-133265-10
Date:
August 30, 2010

LEGEND

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

Y = ------------------------------------------
------ ----------------

Z = ------------------------------
-----------------------

a = -----------------------
------------------------

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

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

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

Date 3 = --------------------

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

  This responds to a letter dated July 27, 2010, and additional correspondence,

submitted on behalf of X, 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

made an election to be treated as an S corporation effective Date 1. X’s election was
inadvertently terminated effective Date 2 when Y and Z, both ineligible shareholders,
PLR-133265-10 2

each acquired X stock in exchange for capital contributions. Prior to Date 2, a was the
sole shareholder of X. On Date 3, Y and Z entered into a redemption agreement with X,
and as a result, a became the sole shareholder of X.

   X represents that the termination was not motivated by tax avoidance or

retroactive tax planning. X and its shareholders have agreed to make any adjustments
that the Commissioner may require, consistent with the treatment of X as an S
corporation.

    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 the termination of X’s S corporation election on Date 2 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 1 and thereafter, provided
X’s S corporation election was valid and provided that the election was not otherwise
terminated under § 1361(d).

     This ruling is conditioned upon the shareholders of X including in income their

pro rata share of the separately stated and nonseparately computed items of X as
provided in § 1366, making any adjustments to basis as provided in § 1367, and taking
into account any distributions made by X as provided in § 1368. If X or its shareholders
fail to treat themselves as described above, this letter ruling shall be null and void.

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

tax consequences of the transactions described above under any other provisions of the
Code.

  This ruling is directed only to the taxpayer that requested it. Section 6110(j)(3)

provides that it may not be used or cited as precedent.
PLR-133265-10 3

   Pursuant to a power of attorney on file, 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 & Special Industries)

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