PLR 201139001: IRS treated an S election as continuing after an inadvertent stock-issuance error

Plain-English summary

An S corporation had an agreement to issue shares to a shareholder but mistakenly treated the shares as not outstanding while holding them in trust. The IRS ruled that, if this error terminated the corporation's S election, the termination was inadvertent under IRC § 1362(f). The corporation could continue to be treated as an S corporation if it filed amended returns, treated the shares as issued, and made the required income and basis adjustments.

Ruling snapshot

• Question: Could the corporation's S election continue after it failed to treat trust-held shares as outstanding?
• Outcome: approved
• Key authorities: IRC §§ 1361(a), 1361(b)(1)(D), 1362(d)(2), 1362(f), 1366, 1367, 1368, and 6110(k)(3); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201139001
Third Party Communication: None
Release Date: 9/30/2011
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
-------------------------------------------- -------------------, ID No. -------------
---------------------------------
Telephone Number:
------------------------------
---------------------
------------------------------------
Refer Reply To:
CC:PSI:B02
PLR-103090-11
Date:
June 14, 2011

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

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

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

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

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

Date 4 = ---------------------------

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

Year = -------

z = -----------

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

This responds to a letter dated December 10, 2010, and subsequent correspondence, submitted on behalf of X, requesting a ruling regarding X’s status as an S corporation.

The information submitted states that X was incorporated on Date 1 in accordance with the laws of State. X elected to be an S corporation effective Date 2.

On Date 3, X and A entered into an agreement stating that A was entitled to receive shares of X stock (the “Unrestricted Shares”). This agreement further stated that X would hold the Unrestricted Shares in trust until A demanded the Unrestricted Shares in writing.

PLR-103090-11
2

X represents that it did not treat the Unrestricted Shares as outstanding shares of X. X was unaware that all of the Unrestricted Shares should have been treated as outstanding as of the date of issuance until its attorneys brought the matter to X’s attention on Date 4.

X now requests a ruling that if X’s failure to treat the Unrestricted Shares as outstanding as of Date 3 terminated X’s S election, then the termination of X constituted an inadvertent termination within the meaning of section 1362(f). X represents that, as a corrective action, X and its shareholders will file amended tax returns for all open tax years. These returns will reflect the Unrestricted Shares as having been issued to A. 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 1361(a)(1) of the Internal Revenue Code 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 the year.

Section 1361(b)(1)(D) provides that, for purposes of subchapter S, the term “small business corporation” means a domestic corporation that is not an ineligible corporation and that does not, among other things, have more than one class of stock.

Section 1.1361-1(I)(1) of the Income Tax Regulations provides that a corporation is generally treated as having only one class of stock if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds.

Section 1.1361-1(I)(2)(i) provides that the determination of whether all outstanding shares of stock confer identical rights to distribution and liquidation proceeds is made based on the corporate charter, articles of incorporation, bylaws, applicable state law, and binding agreements relating to distribution and liquidation proceeds (collectively, the "governing provisions"). Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances.

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

PLR-103090-11
3

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2) or (3), (2) the Secretary 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 is a small business corporation, and (4) the corporation, and each person who was a shareholder in 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 termination, such 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 if X’s S election was terminated, such termination was inadvertent within the meaning of § 1362(f). Therefore, we rule that X will be treated as continuing to be an S corporation from Date 3, and thereafter, provided that X’s S election was not otherwise terminated under § 1362(d).

This ruling is contingent upon X and its shareholders filing amended tax returns for all open tax years, within 120 days of the date of this letter, reflecting the Shares having been issued to A. This ruling is further contingent on A recognizing $z of income in the Year taxable year, arising from the issuance of the Unrestricted Shares.

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 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.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, no opinion is expressed or implied as to whether X has otherwise qualified as an S corporation under § 1361.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

PLR-103090-11
4

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representatives.

Sincerely,

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