PLR 1306004: IRS confirms shareholder distribution provisions do not create a second class of S corporation stock

Plain-English summary

An S corporation planned an agreement governing several types of shareholder distributions, including payments based on shareholders' varying interests in income, discretionary payments, and pro rata distributions based on record-date ownership. The IRS ruled that these provisions would not cause the corporation to have more than one class of stock under IRC § 1361(b)(1)(D). The IRS relied on the submitted facts and representations and noted that varying-interest distributions could be recharacterized if not made within a reasonable time after the relevant taxable year. The ruling did not address the corporation's overall eligibility to be an S corporation.

Ruling snapshot

• Question: Would the planned shareholder distribution provisions create a prohibited second class of S corporation stock?
• Outcome: Approved under the submitted facts and representations.
• Key authorities: IRC §§ 1361(a)(1), 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: 201306004 Third Party Communication: None
Release Date: 2/8/2013 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.02-00, 1362.02-03 -------------------, ID No. -----------------
Telephone Number:
--------------------
---------------------------------------------- Refer Reply To:
----------------------------------------- CC:PSI:B02
------------------- PLR-118550-12
---------------------------- Date:
September 20, 2012

Legend

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

State = ------

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

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

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

   This letter responds to a letter dated April 24, 2012 submitted by X's authorized

representatives on behalf of X, requesting a ruling under § 1361(b)(1)(D) of the Internal
Revenue Code.

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

and subsequently made an election to be treated as an S corporation effective Date 1.
X and its shareholders intend to enter into an agreement (“Agreement”) effective Date 2
which contains provisions relating to minimum distributions to shareholders by X. X and
its shareholders intend that X will make distributions under these provisions based on
the shareholders’ varying interests in X’s income in the current or immediately
preceding taxable year (“Varying Interests Distributions”) or earlier if such earlier year’s
taxable income is adjusted after X’s original return for the such earlier year is filed
(“Discretionary Payments”). X and its shareholders intend that the Varying Interest
Distributions will include year-end and quarterly distributions that enable the
shareholders to make timely estimated and final tax payments.

     In addition to above distributions, X may declare dividends and make pro rata

distributions to the shareholders based on the number of shares that the shareholders
PLR-118550-12 2

own as of a record date (Record Date Distributions). The Agreement will provide that X
will make these Record Date Distributions in accordance with the corporate laws of
State, which provides that all shares of the same class are equal.

  Section 1361(a)(1) provides that for purposes of the Code, the term “S

corporation” means, with respect to the taxable year, a small business corporation for
which an election under § 1362(a) is in effect for the year.

   Section 1361(b)(1)(D) provides that the term “small business corporation” means

a domestic corporation that, among other things, does not have more than one class of
stock. Accordingly, S corporations may not have more than one class of stock.

   Section 1.1361-1(l)(1) of the Income Tax Regulations provides 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.

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

   Section 1.1361-1(l)(2)(iv) provides that a governing provision does not, within the

meaning of § 1.1361-1(l)(2)(i), alter the rights to liquidation and distribution proceeds
conferred by an S corporation's stock merely because the governing provision provides
that, as a result of a change in stock ownership, distributions in a taxable year are to be
made on the basis of the shareholders' varying interests in the S corporation's income in
the current or immediately preceding taxable year. If distributions pursuant to the
provision are not made within a reasonable time after the close of the taxable year in
which the varying interests occur, the distribution may be recharacterized depending on
the facts and circumstances, but will not result in a second class of stock.

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

that the Agreement’s provisions relating to Varying Interests Distributions, Record Date
Distributions and Discretionary Payments do not cause X to have more than one class
of stock for purposes of § 1361(b)(1)(D).
PLR-118550-12 3

   Except for the specific ruling above, we express or imply no opinion concerning

the federal income tax consequences of the facts of this case under any other provision
of the Code. Specifically, we express or imply no opinion regarding X’s eligibility to be
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 the power of attorney on file with this office, a copy of this letter is

being sent to X’s authorized representatives.

                                               Sincerely,



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

Enclosures: (2)

Copy of this letter

Copy for § 6110 purposes

cc: