PLR 201150024: IRS preserved an S corporation election after an inadvertent termination

Plain-English summary

The IRS ruled that a corporation's S corporation election terminated when a shareholder became a nonresident alien. The termination was inadvertent because the corporation and its shareholders did not know that the change in the shareholder's status would end the election. The IRS allowed the corporation to be treated as continuing to be an S corporation after the termination, subject to the election having been valid and not otherwise terminated. The corporation and its shareholders had to make the required S corporation tax adjustments and report items consistently with that treatment.

Ruling snapshot

• Question: Could the corporation continue to be treated as an S corporation after a shareholder became a nonresident alien?
• Outcome: approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368; Treas. Reg. § 1.1362-4.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201150024
Third Party Communication: None
Release Date: 12/16/2011
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.00-00, 1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:B03
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PLR-128781-11
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Date:
August 26, 2011

X = ---------------------------------------------------------------------------------------------------
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State = ------

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

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

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

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

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

This responds to a letter dated July 7, 2011, and subsequent correspondence, submitted on behalf of X by its authorized representatives, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

FACTS

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 2.

On Date 3, A, who was a resident alien, became a shareholder of X. On Date 4, A

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became a nonresident alien, which inadvertently terminated X's S corporation election on Date 4.

X represents that X did not intend for its S corporation election to terminate. X represents that at no time prior to X's external tax advisors informing X of the consequences of A becoming a nonresident alien did X or any of its shareholders know that A's becoming a nonresident alien would terminate X's S corporation status.

X represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its shareholders consent to make any adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary.

LAW AND ANALYSIS

Section 1361(a)(1) 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 such year.

Section 1361(b)(1)(B) provides that the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which does not have a nonresident alien as a shareholder.

Section 1362(d)(2) provides that (A) in general, 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 and (B) any termination under § 1362(d)(2) shall be 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 § 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.

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Section 1.1362-4(b) of the Income Tax Regulations provides that for purposes of
§ 1.1362-4(a), the determination of whether a termination or invalid election was inadvertent is made by the Commissioner. The corporation has the burden of establishing that under the relevant facts and circumstances the Commissioner should determine that the termination or invalid election was inadvertent. The fact that the terminating event or invalidity of the election was not reasonably within the control of the corporation and, in the case of a termination, was not part of a plan to terminate the election, or the fact that the terminating event or circumstance took place without the knowledge of the corporation, notwithstanding its due diligence to safeguard itself against such an event or circumstance, tends to establish that the termination or invalidity of the election was inadvertent.

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 or QSub during the period specified by the Commissioner. In the case of stock held by an ineligible shareholder that causes an inadvertent termination or invalid election for an S corporation under § 1362(f), the Commissioner may require the ineligible shareholder to be treated as a shareholder of the S corporation during the period the ineligible shareholder actually held stock in the corporation. Moreover, the Commissioner may require protective adjustments that prevent the loss of any revenue due to the holding of stock by an ineligible shareholder (for example, a non-resident alien).

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that X’s S corporation election terminated on Date 4 and that the termination 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 4 and thereafter, provided X’s S corporation election was valid and provided that the election was not otherwise terminated under § 1362(d). The shareholders of X, including A, must include their pro-rata share of the separately stated and nonseparately computed items of X as provided in § 1366, make any adjustments to basis as 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 is null and void.

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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(k)(3) provides that it may not be used or cited as precedent.

Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s authorized representatives.

Sincerely,

James A. Quinn
Senior Counsel, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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

cc: