PLR 1252007: IRS treated an inadvertently invalid S corporation election as effective

Plain-English summary

The IRS ruled that a corporation's S corporation election was inadvertently invalid because an ineligible shareholder held an interest on the effective date. The corporation represented that the error was not motivated by tax avoidance, that affected returns consistently treated it as an S corporation, and that the parties would make any required adjustments. The IRS allowed the corporation to be treated as an S corporation from the election's effective date onward, provided the election was otherwise valid and was not later terminated. The ruling addressed only the specified issue and did not express an opinion on other tax consequences.

Ruling snapshot

• Question: Could the corporation receive relief for an inadvertently invalid S corporation election caused by an ineligible shareholder?
• Outcome: approved
• Key authorities: IRC §§ 1361(b), 1361(e), and 1362(f); IRC § 6110(j)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201252007 Third Party Communication: None
Release Date: 12/28/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00, 1361.03-01 ------------------, ID No. -----------------
Telephone Number:
--------------------
------------------ Refer Reply To:
------------------------------ CC:PSI:B02
-------------------------------------- PLR-118955-12
----------------------------- Date:
September 20, 2012

LEGEND

Company = ---------------------------------
----------------------

X = ------------------------------------------------
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Y = ---------------------------------------------
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---------------------------
--------------------------------------------------------------------------------

                        ------------------------------------------------------------------------------------
                        ----------------------

Trust 1 = ------------------------------------------------------------------------------------------

Trust 2 = -----------------------------------------------------------------------------------------

                        ----------------------

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

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

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

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

Date 4 = --------------------------
PLR-118955-12 2

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

This responds to a letter dated May 1, 2012, and additional correspondence, submitted
on behalf of Company, requesting a ruling under § 1362(f) of the Internal Revenue
Code.

The information submitted states that Company was formed in State on Date 1.
Immediately before Date 2, Company’s shareholders were X, Trust 1, and Trust 2.
Company represents that Trust 1 and Trust 2 were eligible to be electing small business
trusts (ESBTs) within the meaning of § 1361(e).

On Date 2, X transferred an interest in Company to Y, an ineligible shareholder.
Company made an election to be treated as an S corporation effective Date 3, however
such election was invalid because Company had an ineligible shareholder, Y, on the
effective date. Also on Date 3, Trust 1 and Trust 2 timely filed elections to be ESBTs.
On Date 4, X and Y entered into a transaction that caused the transferred interest in
Company to once again be owned by an eligible shareholder.

Company represents that its S corporation invalid election was inadvertent and not
motivated by tax avoidance or retroactive tax planning. Company also represents that
all income has been reported on all affected returns of Company and all of its
shareholders consistent with the treatment of Company as an S corporation, and that
neither Company nor any of its shareholders intended to make an invalid Subchapter S
election. Company and its shareholders have agreed to make any adjustments that the
Commissioner may require, consistent with the treatment of Company as an S
corporation.

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.
PLR-118955-12 3

Based solely on the facts submitted and the representations made, we conclude that
the ineffectiveness of Company's S corporation election constituted an inadvertent
invalid election within the meaning of section 1362(f). Therefore, Company will be
treated as an S corporation effective Date 3 and thereafter, provided Company's S
corporation election was otherwise valid and not otherwise terminated under section
1362(d).

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(j)(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 Company’s
authorized representatives.

                                  Sincerely,




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

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

cc: