PLR 1314014: IRS preserves an S corporation election after an inadvertent second class of stock

Plain-English summary

A corporation asked the IRS to address an S corporation election that became ineffective because its charter created two classes of stock with different liquidation rights. The corporation amended its charter to eliminate the preferential liquidation rights, leaving voting differences between the classes. The IRS concluded that the problem was inadvertent and allowed the corporation to be treated as an S corporation from the original effective date, assuming the election was otherwise valid and had not otherwise terminated. The ruling did not decide the corporation's general eligibility for S corporation status.

Ruling snapshot

• Question: Can the corporation continue to be treated as an S corporation after an inadvertent second class of stock invalidated its election?
• Outcome: Approved, subject to the stated conditions.
• Key authorities: IRC §§ 1361 and 1362; Treas. Reg. § 1.1361-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201314014 Third Party Communication: None
Release Date: 4/5/2013 Date of Communication: Not Applicable
Index Number: 1361.01-04, 1362.04-00
Person To Contact:
---------------------------------- -----------------------, ID No. -------------------
------------------------- ---------------------------------------------------
--------------------------- Telephone Number:
------------------------------------ ----------------------
Refer Reply To:
CC:PSI:B01
PLR-132422-12
Date:
January 08, 2013

Legend

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

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

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

Date1 = --------------------------

Date2 = ----------------------------

Date3 = --------------------------

Date4 = ----------------------

y= -------

z= -----

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

This responds to a letter dated July 16, 2012, submitted on behalf of X, requesting a
ruling under § 1362(f) of the Internal Revenue Code.

                                                 FACTS

PLR-132422-12 2

The information submitted states that X was incorporated under the laws of State on
Date1. On Date2, X’s Board of Directors adopted a Plan of Recapitalization providing
for y shares of voting Class A Common Stock with a par value of $z and y shares of
non-voting Class B Common Stock with no par value. The Plan of Recapitalization also
provided the Class A shares with preferential rights on liquidation.

A has owned 100% of the outstanding shares of both classes of stock since Date3 and
is entitled to all of the corporation’s assets on liquidation.

X elected to be treated as an S corporation effective Date4, while it had two classes of
stock outstanding. After discovering the invalidity of the S election, X amended its
Certification of Incorporation to eliminate the Class A share’s preferential rights on
liquidation and to provide that the only difference between the two classes of stock is
that Class A is voting stock and Class B is non-voting stock.

X represents that the circumstances resulting in the ineffectiveness of X’s S corporation
election were inadvertent and were not motivated by tax avoidance. X also represents
that X and its shareholder have filed all returns consistent with X’s status as an S
corporation since Date4. X and its shareholder have agreed to make such adjustments
(consistent with the treatment of X as an S corporation) as 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 such year.

Section 1361(b)(1) provides that the term “small business corporation” means a
domestic corporation which is not an ineligible corporation and 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 one class of stock.

Section 1.1361-1(l)(1) of the Income Tax Regulations provides, in part, 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. 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.
PLR-132422-12 3

Section 1.1361-1(l)(2)(i) provides, in part, that the determination of 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 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)(A) provides that an election under § 1362(a) will 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.

Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (3); (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; and (4) the corporation for which the termination
occurred, and each person who was a shareholder in 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 termination, such corporation shall be treated as an S corporation during the
period specified by the Secretary.

                                 CONCLUSION

Based solely on the information submitted and the representations made, we conclude
that X’s S corporation was ineffective for the taxable year beginning Date4. We further
conclude that the circumstances resulting in such ineffectiveness were inadvertent
within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X
will be treated as an S corporation from Date4, provided X’s S corporation election was
otherwise valid and has not otherwise terminated under § 1362(d).

Except as specifically set forth above, no opinion is expressed concerning the federal
tax consequences of the facts described above under any other provisions of the Code.
PLR-132422-12 4

Specifically, no opinion is expressed regarding X’s eligibility to be treated as an S
corporation.

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.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your 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 for § 6110 purposes

cc: