PLR 201126009: Inadvertent S corporation termination was disregarded

Plain-English summary

The IRS considered a corporation whose S corporation election was inadvertently terminated when an ineligible shareholder acquired its stock. The corporation represented that the termination was not motivated by tax avoidance and agreed to make any required adjustments. The IRS ruled that the termination was inadvertent and that the corporation would continue to be treated as an S corporation from the termination date, provided its original election was valid and was not otherwise terminated. The corporation had to remove the ineligible shareholder within 120 days, and its shareholders had to report items, adjust basis, and account for distributions consistently with S corporation treatment.

Ruling snapshot

• Question: Could the corporation continue as an S corporation after an ineligible shareholder caused an inadvertent termination?
• Outcome: Approved, subject to corrective action within 120 days.
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, and 1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201126009
Third Party Communication: None
Release Date: 7/1/2011
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:B02
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PLR-137628-10
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Date:
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March 14, 2011

X = ------------------------------------------------------------------------------------------------------
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Y = ------------------------------------------------------------------------------------------------------
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D1 = -------------------

D2 = ---------------------------

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

Dear -----------------

This letter responds to a letter dated September 10, 2010, and subsequent correspondence, submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated in State and elected to be an S corporation effective D1. X’s election was inadvertently terminated effective D2 when Y, an ineligible shareholder, became the owner of X stock. Upon the issuance of a favorable ruling, X will take corrective action so that Y will no longer be a shareholder of X.
PLR-137628-10
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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 event resulting in the 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, the corporation shall 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 D2 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 D2 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, taking into account any distributions made by X as provided in § 1368, and taking corrective action so that Y is no longer a shareholder of X within 120 days from the date of this letter. 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 who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.
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Pursuant to a power of attorney on file with this office, a copy of this letter is being forwarded to X’s authorized representative.

Sincerely,

Melissa C. Liquerman
Chief, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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

cc: