PLR 1236003: IRS upholds S corporation status after disproportionate distributions

Plain-English summary

The IRS ruled that a corporation's disproportionate distributions and later corrective distributions did not create a second class of stock or terminate its S corporation election. The corporation's governing provisions and state law gave all shares identical distribution and liquidation rights, and there was no agreement granting a shareholder a preference. The distributions still had to receive appropriate tax treatment based on the facts. The ruling did not decide whether the corporation otherwise qualified as an S corporation.

Ruling snapshot

• Question: Do disproportionate and corrective distributions create a second class of stock or terminate the S corporation election?
• Outcome: Approved, with appropriate tax treatment required for the distributions.
• Key authorities: IRC § 1361(a), § 1361(b)(1)(D), and § 1362(a); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201236003 Third Party Communication: None
Release Date: 9/7/2012 Date of Communication: Not Applicable
Person To Contact:
Index Numbers: 1361.01-04, 1362.04-00 ----------------------, ID No. -----------------
Telephone Number:
--------------------
-------------------------------- Refer Reply To:
------------------------------------------ CC:PSI:B03
--------------------------------------------- PLR-101875-12
----------------------- Date:
April 11, 2012

                                                LEGEND

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

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

Date = -----------------------
1
Date = --------------------------
2
Date = ----------------------
3

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

    This responds to a letter dated December 29, 2011, and subsequent

correspondence, submitted on behalf of X by its authorized representative, requesting a
ruling under § 1361(b)(1)(D) of the Internal Revenue Code.

                                                 FACTS

     The information submitted states that X was incorporated under the laws of State

and filed an S corporation election effective for its taxable year beginning Date 1. From
Date 1 through Date 2, X made disproportionate allocations of income and
disproportionate distributions to its shareholders. X represents that under State law, all
of X’s stock have identical rights to distribution and liquidation proceeds. No provision
in X’s articles of incorporation, bylaws, or any other governing instruments altered those
rights. X further represents that there is no agreement, written or oral, that any
PLR-101875-12 2

shareholder would be entitled to a preference regarding X’s distribution or liquidation
proceeds.

    X represents that starting Date 3, it will make the represented adjustments to

rectify the disproportionate allocations of income and distributions made from Date 1 to
Date 2.

                               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)(D) provides that, for purposes of subchapter S, the term

“small business corporation” means a domestic corporation which is not an ineligible
corporation and which does not, among other things, have more than one class of
stock.

   Section 1.1361-1(l)(1) of the Income Tax Regulations provides, in part, that a

corporation that has more than one class of stock does not qualify as a small business
corporation. Except as provided in § 1.1361-1(l)(4) (relating to instruments, obligations,
or arrangements treated as a second class of stock), a corporation is 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. Differences in voting stock
among shares of stock of a corporation are disregarded in determining whether a
corporation has more than one class of stock.

   Section 1.1361-1(l)(2)(i) provides, in part, 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.

    In § 1.1361-1(l)(2)(vi), Ex. 2 (Distributions that differ in timing), S, a corporation,

has two equal shareholders, A and B. Under S’s bylaws, A and B are entitled to equal
distributions. S distributes $50,000 to A in the current year, but does not distribute
$50,000 to B until one year later. The circumstances indicate that the difference in
timing did not occur by a binding agreement relating to distribution or liquidation
proceeds. The example concludes that under § 1.1361-1(l)(2)(i), the difference in timing
of the distributions to A and B does not cause S to be treated as having more than one
PLR-101875-12 3

class of stock. However, § 7872 or other recharacterization principles may apply to
determine the appropriate tax consequences.

                                  CONCLUSION

    Based solely on facts submitted and representations made, we conclude that

because X has identical distribution and liquidation rights under its governing provisions,
the difference in timing between X’s disproportionate distributions and the corrective
distributions to its shareholders does not cause X to be treated as having more than one
class of stock for purposes of § 1361(b)(1)(D). However, X’s disproportionate and
corrective distributions to its shareholders must be given appropriate tax effect. Under
these circumstances, we conclude that X’s S corporation election did not terminate
because of the disproportionate and corrective distributions.

    Except as expressly provided herein, we express or imply no opinion concerning

the tax consequences of any aspect of any transaction or item discussed or referenced
in this letter. Specifically, we express or imply no opinion regarding X’s eligibility to be
an S corporation for federal tax purposes.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3)

provides that it may not be used or cited as precedent.

  In accordance with a power of attorney on file with this office, we are sending a

copy of this letter to your authorized representative.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

                                   Sincerely,



                                   Richard T. Probst
                                   Senior Technician Reviewer, Branch 3
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosures (2):

   A copy of this letter
   A copy for § 6110 purposes

cc: