S corporation election reinstated after inadvertent ineligible-shareholder transfer

Plain-English summary

An S corporation asked the IRS for relief after transferring part of its stock to an ineligible limited liability company shareholder. The corporation and its shareholders did not intend to end the S election, and they corrected the ownership problem after discovering it. The IRS ruled that the election terminated when the transfer occurred but that the termination was inadvertent, so the corporation would continue to be treated as an S corporation from that date, subject to the stated conditions. The ruling required the corporation and its shareholders to continue treating the corporation as an S corporation and to make any required adjustments.

Ruling snapshot

• Question: Can the corporation receive relief under IRC § 1362(f) after an ineligible shareholder caused its S election to terminate?
• Outcome: Approved.
• Key authorities: IRC §§ 1361 and 1362; Treas. Reg. § 1.1362-4; 26 U.S.C. § 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201145002
Third Party Communication: None
Release Date: 11/10/2011
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------
-----------, ID No. -----------------
----------------------------------------------- Telephone Number:
---------------------------
---------------------
--------------------------
Refer Reply To:
CC:PSI:B01
PLR-106773-11
Date:
August 29, 2011

Legend:

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

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

D1 = ------------------

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

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

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

This responds to the letter dated February 9, 2011, and related correspondence, submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue Code (ACode@) for an inadvertent termination of S election.

FACTS

The information submitted states that X was incorporated under the laws of State on D1. X elected to be treated as an S corporation, effective D1. On D2, X transferred a portion of the X stock to Y, a limited liability company.
PLR-106773-11
2

X and its shareholders were unaware of the fact that Y was an ineligible shareholder and did not intend the S election to terminate. Immediately after the discovery of the error, X took remedial action by having Y distribute its X stock to its individual shareholders so that all of the shareholders of X were again eligible shareholders. Additionally, X and its shareholders agree to make any adjustments required by the Commissioner consistent with the treatment of X as an S corporation.

LAW AND ANALYSIS

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a small business corporation cannot 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.

Section 1362(a) provides that a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall 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(f) provides in part 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 consent, or (B) was terminated under § 1362(d)(2) or (3), (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 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 this subsection, 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, such corporation shall be treated as an S corporation during the period specified by the Secretary.

Section 1.1362-4(d) 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.
PLR-106773-11
3

CONCLUSION

Based solely upon the facts submitted and the representations made, we conclude that X’s S election terminated on D2. We further conclude that the termination of X’s S election constituted an inadvertent termination within the meaning of § 1362(f).

Under § 1362(f), X will be treated as an S corporation from D2, and thereafter, provided that X’s S election was otherwise valid and has not otherwise terminated under § 1362(d).

This ruling is contingent upon X and all its shareholders treating X as having been an S corporation for the period beginning D2, and thereafter.

Except as specifically ruled upon above, no opinion is expressed as to the federal income tax consequences of the facts described above under any other provision 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.

In accordance with the Power of Attorney on file with this office, copies of this letter ruling will be sent to your authorized representative.

Sincerely,

Laura C. Fields
Laura C. Fields
Acting Senior Technician Reviewer, Branch 1 Office of the Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures (2)

Copy of this letter
Copy for ' 6110 purposes