IRS grants relief for an inadvertent S-corporation termination

Plain-English summary

The IRS ruled that a corporation’s S-corporation election terminated when its shares were transferred to an ineligible shareholder. The corporation and the affected parties did not intend to terminate the election, and they reported consistently with S-corporation treatment. The IRS concluded that the termination was inadvertent under IRC § 1362(f). The corporation would therefore be treated as an S corporation from the transfer date and afterward, provided its election was otherwise valid and did not otherwise terminate.

Ruling snapshot

• Question: Was the corporation’s S-corporation termination inadvertent and eligible for relief under IRC § 1362(f)?
• 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: 201303009 Third Party Communication: None
Release Date: 1/18/2013 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------ --------------------, ID No. -----------------
-------------------------------------------------- Telephone Number:
------------------------------ ---------------------
-------------------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-139474-12
Date:
October 15, 2012

LEGEND

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

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

M = -----------------------------

N = --------------------------------

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

q = --------------------------------

d1 = -----------------------

d2 = ----------------------

d3 = -------------------------

d4 = -------------------

PLR-139474-12 2

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

  This letter responds to a letter, dated September 12, 2012, and subsequent

correspondence, on behalf of X from X's authorized representative, requesting
inadvertent termination relief under §1362(f) of the Internal Revenue Code.

FACTS

   According to the information submitted, X was incorporated under the laws of

State on d1, and elected to be treated as an S corporation effective d2. On d3, the sole
shareholder of X transferred all of the shareholder’s shares of X stock to A. A was a q,
an ineligible shareholder pursuant to § 1361(b)(1). As such, X’s status as an
S corporation terminated. The former shareholder of X and the owners of A did not
intend to terminate X’s status as an S corporation. X represents that the transfer of
shares to A was not motivated by tax avoidance, and neither X nor the owners of A
intended to obtain, nor did obtain, a tax benefit by having A as a shareholder.

   On d4, A distributed all the shares of X that it held in equal part to the owners of

A, M and N. Between d3 and d4, the income, gain, loss, deductions, and credits from X
that A allocated to M and N were equal to the income, gain, loss, deductions, and
credits that would have been allocated to M and N if they had been the shareholders of
X during that time.

  X and each person that was a shareholder of X subsequent to d3 filed their

United States income tax returns in a manner consistent with the treatment of X as an
S corporation. X, M, and N each agree to make any adjustments consistent with the
treatment of X as an S corporation that the Secretary may require.

  X requests a ruling that the termination of its S corporation election was

inadvertent within the meaning of §1362(f).

LAW AND ANALYSIS

    Section 1361(a) 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, in part, that the term "small business

corporation" means a domestic corporation which is not an ineligible corporation and
which 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.

PLR-139474-12 3

  Section 1362(a) provides that, except as provided in §1362(g), a small business

corporation may elect to be an S corporation.

   Section 1362(d)(2) provides that an election under § 1362(a) shall be terminated

whenever (at any time on or after the 1st day of the 1st taxable year for which the
corporation is an S corporation) such corporation ceases to be a small business
corporation, and that any termination under § 1362(d)(2) shall be effective on and after
the date of cessation.

   Section 1362(f) provides, in part, that if -- (1) an election under § 1362(a) by any

corporation was terminated under § 1362(d)(2); (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 circumstances resulting in such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, or to acquire the required shareholder consents; and (4)
the corporation for which the termination occurred, and each person who was a
shareholder in such corporation at any time during the period specified pursuant to
§ 1362(f), agrees to make such adjustments (consistent with the treatment of such
corporation as an S corporation) as may be required by the Secretary with respect to
such period, then, notwithstanding the circumstances resulting in such termination, such
corporation shall be treated as an S corporation during the period specified by the
Secretary.

CONCLUSION

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

X's S corporation election was terminated on d3 because A was an ineligible
shareholder of X. We further conclude that the termination of X's S corporation election
constituted an inadvertent termination within the meaning of §1362(f). Under the
provisions of §1362(f), X will be treated as an S corporation from d3, and thereafter,
provided that, apart from the inadvertent termination described above, X's S corporation
election was otherwise valid and has not otherwise terminated under §1362(d).

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the transactions described above under any other
provision of the Code. Specifically, except as specifically ruled above, we express or
imply no opinion regarding X‘s eligibility to be an S corporation.

PLR-139474-12 4

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

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

                                  Sincerely,


                                  David R. Haglund
                                  David R. Haglund
                                  Chief, Branch 1
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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