PLR 1308008: IRS grants relief for a possible second class of stock

Plain-English summary

The IRS granted relief to a corporation whose redemption agreement may have created a second class of stock and made its S corporation election invalid. The corporation represented that any invalidity was inadvertent and agreed to make any adjustments required by the IRS. The IRS ruled that the corporation would be treated as an S corporation from the election's effective date, provided the election was otherwise valid and was not later terminated for another reason.

Ruling snapshot

• Question: Could the corporation's S corporation election remain effective despite a redemption agreement that may have created a second class of stock?
• Outcome: Approved, the IRS granted relief under IRC § 1362(f).
• Key authorities: IRC §§ 1361(a)(1), 1361(b)(1)(D), 1362(f), and 6110(k)(3); Treas. Reg. §§ 1.1361-1(l)(1) and 1.1361-1(l)(2)(iii)(A).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201308008 Third Party Communication: None
Release Date: 2/22/2013 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.00-00, 1362.04-00 -----------------------------, ID No. --------------
-----------------------------------------------------
Telephone Number:

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

------------------------------- Refer Reply To:
------------------------------------------- CC:PSI:B01
------------------------------------- PLR-122390-12
--------------------------------------- Date:
November 07, 2012

LEGEND
X = ---------------------------------------------------------------------------------

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

Shareholder 1 = ------------------
-
a = ------

D1 = -------------------

D2 = -----------------------

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

   This responds to a letter dated May 23, 2012, and subsequent correspondence,

submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue
Code.

Facts

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

State on D1. X made an election to be treated as an S corporation effective D1. Also
on D1, X and Shareholder 1 entered into a redemption agreement with respect to a of
Shareholder 1’s shares of X. On D2, X redeemed a of Shareholder 1’s shares pursuant
to the redemption agreement. X subsequently discovered that X’s election may have
PLR-122390-12 2

been inadvertently invalid because the redemption agreement may have created a
second class of stock.

   X represents that if X’s S election was ineffective, the invalidity of its S election

was inadvertent. X and its shareholders agree to make any adjustments (consistent
with the treatment of X as an S corporation) that the Secretary may require.

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 that is not an ineligible
corporation and that does not, among other things, have more than one class of stock.

   Section 1.1361-1(I)(1) of the Income Tax Regulations provides that a corporation

is generally 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 rights 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)(iii)(A) of the Income Tax Regulations provides that, in

general, redemption agreements are disregarded in determining whether a corporation’s
outstanding shares of stock confer identical distribution and liquidation rights unless (1)
a principal purpose of the agreement is to circumvent the one class of stock
requirement of § 1361(b)(1)(D) and § 1.1361-1(l), and (2) the agreement establishes a
purchase price that, at the time the agreement is entered into, is significantly in excess
of or below the fair market value of the stock.

    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 it was 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 such
ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of
time after discovery of the event resulting in the ineffectiveness or termination, 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
PLR-122390-12 3

such period, then, notwithstanding the circumstances resulting in such ineffectiveness
or termination, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

Conclusion

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

that X’s S corporation election on D1 may have been invalid, and thus not effective,
because X may have had more than one class of stock. We conclude that if X’s S
election was ineffective, the invalidity was inadvertent within the meaning of § 1362(f).
We further hold that, pursuant to the provisions of § 1362(f), X will be treated as an S
corporation from D1, and thereafter, provided X’s S corporation election was otherwise
valid and provided that the election was not otherwise terminated under § 1361(d).

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed concerning whether X
was otherwise eligible to be an S corporation.

  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.

  Pursuant to the power of attorney on file with this office, a copy of this letter will

be sent to X’s authorized representative.

                                       Sincerely,



                                       Laura C. Fields
                                       Laura C. Fields
                                       Senior Technician Reviewer, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosures (2)

Copy of this letter
Copy of this letter for § 6110 purposes

cc: