PLR 1245002: IRS treats an inadvertent S corporation termination as continuing

Plain-English summary

The IRS ruled that a corporation's S election terminated when one shareholder transferred stock to an ineligible partnership. The corporation promptly corrected the problem, and the IRS found that the termination was inadvertent rather than a tax-avoidance arrangement. The corporation and its shareholders agreed to make any required adjustments. The IRS therefore treated the corporation as an S corporation from the termination date onward, assuming its election was otherwise valid and not separately terminated.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment after stock was transferred to an ineligible shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201245002 Third Party Communication: None
Release Date: 11/9/2012 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------- ----------------------, ID No. -------------
-------------------------- Telephone Number:
---------------------------- ---------------------
------------------------------ Refer Reply To:
CC:PSI:B02
PLR-102517-12
Date:
July 06, 2012

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

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

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

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

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

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

This letter responds to a letter dated January 4, 2012, 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 formed under the laws of State on Date 1
and elected to be treated as an S corporation effective Date 2. As of Date 3, eligible S
corporation shareholders owned all of the stock of X. On Date 3, however, one of X’s
shareholders contributed their stock in X to A, a partnership which is an ineligible S
corporation shareholder under § 1361(b)(1)(B). X represents that upon discovery of its
PLR-102517-12 2

error, it promptly took remedial action. Effective Date 4, A transferred all of its X shares
to an eligible S corporation shareholder.

X represents that the transfer of X stock to A, an ineligible shareholder, was not
motivated by avoidance or retrospective tax planning. X and its shareholders have
continued to treat X as an S corporation at all times. X and its shareholders agree to
make any adjustments (consistent with the treatment of X as an S corporation) that the
Secretary may require.

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” means a domestic
corporation that is not an ineligible corporation and that does not 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(d)(2) 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 a
corporation is an S corporation) such corporation ceases to be a small business
corporation. A termination of an S corporation election under § 1362(d)(2) is effective
on and after the date of cessation.

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 event resulting in the ineffectiveness,
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 information submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 3, when X stock was transferred to A,
an ineligible shareholder. We also conclude that this termination was inadvertent within
the meaning of § 1362(f), and that under the provisions of § 1362(f), X will be treated as
an S corporation from Date 3, and thereafter, provided that X’s S election was valid and
was not otherwise terminated.
PLR-102517-12 3

Except as specifically ruled upon above, we express no opinion concerning the federal
tax consequences of the facts described above under any other provision of the Code.
Specifically, no opinion is expressed on whether X was otherwise eligible to be treated
as an S corporation.

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.

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

                                    Sincerely,



                                    Bradford R. Poston
                                    Senior Counsel, Branch 2
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

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