PLR 1313002: QSub status treated as continuing after inadvertent termination

Plain-English summary

The IRS ruled that a subsidiary's qualified subchapter S subsidiary election terminated when a lender acquired shares of the subsidiary, because the parent corporation was no longer its sole shareholder. The IRS found that the termination was inadvertent and allowed the subsidiary to be treated as a QSub during the specified period, provided the parent and subsidiary met the ruling's conditions. The ruling required the parties to reverse the lender's acquisition of shares within 120 days. If they failed to take that corrective action, the ruling would be null and void.

Ruling snapshot

• Question: Could the subsidiary continue to be treated as a QSub after a lender acquired its shares?
• Outcome: Approved, subject to reversing the share acquisition within 120 days.
• Key authorities: IRC §§ 1361 and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201313002 Third Party Communication: None
Release Date: 3/29/2013 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.03-02
Person To Contact:
------------------------------- ---------------- --------------------, ID No. --------------
------------------------------------ Telephone Number:
------------------------------ ----------------------
------------------------------------- Refer Reply To:
CC:PSI:B02
PLR-125836-12
Date:
November 21, 2012

Legend

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

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

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

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

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

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

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

  This letter responds to a letter dated June 12, 2012, submitted by X's authorized

representative on behalf of X and Y, requesting inadvertent termination relief under §
1362(f) of the Internal Revenue Code.

   The information submitted states that X incorporated on Date 1 under the laws of

State and elected to be treated as an S corporation effective Date 2. X's subsidiary, Y,
incorporated on Date 3 under the laws of State and X elected to treat Y as a qualified
subchapter S subsidiary (QSub) effective Date 3.
PLR-125836-12 2

  On Date 4, X, Y and a lender (“Lender”) entered into an agreement under which

Lender agreed to acquire shares of Y. As a result of Lender’s acquisition of Y stock, Y’s
QSub status terminated, as X was no longer the sole shareholder of Y. .

     X represents that the above transactions were not motivated by tax avoidance or

retroactive tax planning. During the years at issue, all tax returns for X were filed on
Form 1120S. All relevant parties have treated X as an S corporation and Y as a QSub
at all times. X, Y, and all shareholders of X and Y, agree to make any adjustments
(consistent with the treatment of X as an S corporation and Y as a QSub) that the
Secretary may require.

  Section 1361(a)(1) of the Code defines an “S corporation” as a small business

corporation for which an election under § 1362(a) is in effect for such year.

   Section 1361(b)(3)(B) defines a QSub as any domestic corporation which is not

an ineligible corporation (as defined in § 1361(b)(2)), if (i) 100 percent of the stock of
such corporation is held by the S corporation, and (ii) the S corporation elects to treat
such corporation as a QSub.

    Section 1362(f) provides that if (1) an election under § 1362(a) or

§ 1361(b)(3)(B)(ii) 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 paragraph (2) or (3) of § 1362(d), (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 circumstances resulting in
such 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 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.

  Based solely on the information submitted and the representations made, we

conclude that Y's QSub election terminated on Date 4, the date Lender acquired shares
of Y. We also conclude that this termination was inadvertent within the meaning of
§ 1362(f), and that under the provisions of § 1362(f), Y will be treated as a QSub from
Date 4, and thereafter, provided that X's S election was valid and was not otherwise
terminated and that Y’s QSub election was valid and not otherwise terminated.

  This ruling is conditioned on X and Y taking the corrective action of reversing

Lender’s acquisition of shares in Y within 120 days of the date of this letter. X will be
PLR-125836-12 3

treated as the sole shareholder of Y from Date 4 and thereafter. If this corrective action
is not taken, then this ruling is null and void.

   Except as specifically ruled upon above, we express no opinion concerning the

federal tax consequences of the transactions described above under any other
provisions of the Code. Specifically, no opinion is expressed on whether Y was
otherwise eligible to be treated as a QSub.

   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 representative.

                                               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