PLR 1310008: IRS grants relief for an inadvertent S corporation election termination

Plain-English summary

The IRS considered a corporation whose S corporation election terminated after shares were transferred to an ineligible shareholder. The corporation and its shareholders corrected the ownership problem and represented that they had not intended to terminate the election or avoid tax. The IRS ruled that the termination was inadvertent under IRC § 1362(f). The corporation therefore would continue to be treated as an S corporation from the termination date, provided its election was not otherwise terminated under § 1362(d). The ruling mattered because it preserved the corporation's S corporation status after the corrective transfer.

Ruling snapshot

• Question: Can the corporation receive relief after its S corporation election terminated because an ineligible shareholder held its shares?
• Outcome: Approved, inadvertent termination relief granted.
• Key authorities: IRC §§ 1361(a), 1361(b), 1362(a), 1362(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201310008 Third Party Communication: None
Release Date: 3/8/2013 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.02-03
Person To Contact:
------------------------------------- ----------------, ID No. ------------------
------------------------------- Telephone Number:
----------------------------------- ----------------------
--------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-123892-12
Date:
November 28, 2012

LEGEND

X = ------------------------.
-------------------------

Y = ---------------------------------------------------------------
--------------------------

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

Trust = ----------------------------------------------------
---------------------------

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

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

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

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

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

Dear -----------------:
PLR-123892-12 2

This responds to a letter signed May 1, 2012, submitted on behalf of X by X’s
authorized representative, requesting relief under section 1362(f) of the Internal
Revenue Code (the Code).

FACTS

According to the information submitted and representations within, X was incorporated
on Date 1, under the laws of State. Effective Date 2, X elected to be treated as an S
corporation.

Trust held shares of X. On Date 3, Trust transferred shares of X to Y. On Date 4,
additional shares were transferred to Y at A’s direction. Y was an ineligible S
corporation shareholder. As a result, X’s S election terminated on Date 3. X and its
shareholders took corrective action and transferred the X shares from Y to A.

X represents that neither it nor any of its shareholders intended to terminate X’s
Subchapter S election. In addition, X represents that other than the inadvertent
termination, X has qualified as a small business corporation at all times since Date 2. X
represents that its S corporation election termination was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. Further, X represents that X
and its shareholders agree to make any adjustments required as a condition of
obtaining relief under the inadvertent termination rule as provided under § 1362(f) of the
Code that may be required by the Secretary.

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 the year. Section 1361(b)(1) defines a “small business corporation” as a
domestic corporation which is not an ineligible corporation which does not (A) have
more than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more than 1
class of stock.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the taxable year for which the
corporation is an S corporation) such corporation ceases to be a small business
corporation.

Section 1362(f) provides in part that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d), (2) the Secretary determines that the
circumstances resulting in the termination were inadvertent, (3) no later than a
reasonable period of time after the discovery of the circumstances resulting in the
termination, steps were taken so that the corporation for which the termination occurred
PLR-123892-12 3

is a small business corporation, 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 of inadvertent termination of the S election, agrees to makes 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 termination, the corporation is 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 corporation election terminated on Date 3. However, we further conclude that the
termination was inadvertent within the meaning of § 1362(f). Therefore, X will be
treated as an S corporation effective Date 3 and thereafter, provided X’s S corporation
election is not otherwise terminated under § 1362(d).

Except as specifically ruled upon above, we express or imply no opinion concerning the
federal 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 requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to the taxpayer’s authorized representative.

                                    Sincerely,


                                    Joy Spies
                                    Joy Spies
                                    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 section 6110 purposes

cc: