PLR 1320008: IRS restores S corporation treatment after an inadvertent termination

Plain-English summary

The IRS considered a corporation's request to preserve its S corporation status after the election terminated because the corporation had accumulated earnings and profits and excessive passive investment income for three consecutive years. The IRS found that the termination was inadvertent and allowed the corporation to continue being treated as an S corporation. The corporation had to amend a later-year return, make a deemed dividend election, amend shareholder returns, and make a specified payment within the required periods. The relief was conditional, and the ruling would become void if those requirements were not met.

Ruling snapshot

• Question: May the corporation continue to be treated as an S corporation after its election terminated because of accumulated earnings and profits and passive investment income?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, 1368, and 1375; Treas. Reg. § 1.1368-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201320008 Third Party Communication: None
Release Date: 5/17/2013 Date of Communication: Not Applicable
Index Numbers: 1362.00-00, 1362.02-00,
1362.02-03, 1362.04-00 Person To Contact:
-----------------------, ID No. -------------------
----------------------------------- ---------------------------------------------------
-------------- Telephone Number:
---------------------------------- ----------------------
----------------------------------------- Refer Reply To:
CC:PSI:B03
PLR-133372-12
Date:
January 07, 2013

                                           LEGEND

Company = -------------------------------------------------------------------------------------------------
-----------------------

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

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

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

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

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

a = ------------

b = ----------

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

  This letter responds to a letter dated August 2, 2012, and subsequent

correspondence, submitted on behalf of Company by Company’s authorized

PLR-133372-12 2

representative, requesting a ruling under § 1362(f) of the Internal Revenue Code
(Code).

                                     FACTS

   According to the information submitted, Company incorporated under the laws of

State on Date 1. Company elected to be an S corporation effective Date 2. At the
close of three consecutive taxable years ending Year 3, Company had subchapter C
accumulated earnings and profits (AE&P) of $a. Moreover, for each taxable year
ending Year 1, Year 2, and Year 3, Company had passive investment income (within
the meaning of § 1362(d)(3)) in excess of 25 percent of its gross receipts. As a result,
Company’s S election terminated on Date 3.

   Company represents that the circumstances resulting in the termination of

Company’s S corporation election were inadvertent and were not motivated by tax
avoidance or retroactive tax planning. Company further represents that Company and
Company’s shareholders have filed tax returns consistent with Company being an S
corporation. Company and its shareholders agree to make any adjustments consistent
with the treatment of Company as an S corporation as may be required by the Secretary
with respect to the period specified by § 1362(f).

                              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 1362(d)(3)(A)(i) provides that an election under § 1362(a) shall be

terminated whenever the corporation has accumulated earnings and profits at the close
of each of three consecutive taxable years, and has gross receipts for each of the
taxable years more than 25% of which are passive investment income.

   Section 1362(d)(3)(A)(ii) provides that the termination under § 1362(d)(3) shall be

effective on and after the first date of the first tax year beginning after the third
consecutive taxable year referred to in § 1362(d)(3)(A)(i).

   Section 1362(f) provides 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 such corporation at any time
during the period specified pursuant to 1362(f), agrees to make such adjustments
(consistent with the treatment of such corporation as an S corporation) as may be

PLR-133372-12 3

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.

  Section 1368(c) provides rules for determining the source of distributions made by

an S corporation having accumulated earnings and profits with respect to its stock.
Section 1368(e)(3) and § 1.1368-1(f)(2) of the Income Tax Regulations provide that an
S corporation may, with the consent of all of its affected shareholders, elect to distribute
earnings and profits first.

    Section 1.1368-1(f)(3) provides, in part, that an S corporation may elect to

distribute all or part of its subchapter C earnings and profits through a deemed dividend.
If an S corporation makes the election provided in § 1.1368-1(f)(3), the S corporation
will be considered to have made the election provided in § 1.1368-1(f)(2) (relating to the
election to distribute earnings and profits first).

    Section 1375(a) provides that if an S corporation has accumulated earnings and

profits at the close of a taxable year and gross receipts for that taxable year more than
25 percent of which are passive investment income, then there is imposed a tax on the
income of such corporation for such taxable year. Such tax shall be computed by
multiplying the excess net passive income by the highest rate of tax specified in § 11(b).

                                  CONCLUSION

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

conclude that Company’s S corporation election terminated on Date 3, under
§ 1362(d)(3)(A), because Company had AE&P at the close of each of three consecutive
tax years, Year 1, Year 2, and Year 3, and had gross receipts for each of those years of
which more than 25% of which were passive investment income. We further conclude
that the termination was inadvertent within the meaning of § 1362(f).

     Pursuant to the provisions of § 1362(f), Company will be treated as continuing to

be an S corporation beginning on Date 3, and thereafter, provided that Company’s S
corporation election was valid and has not otherwise terminated under § 1362(d) and the
following conditions are met. Within 120 days from the date of this letter, Company
shall file an amended income tax return for its Year 4 tax year, electing pursuant to
§ 1.1368-1(f)(3) to make a deemed dividend of $a. Also, within 120 days, the Year 4
income tax return(s) of the shareholders of Company must be amended to reflect the
changes made to Company’s Year 4 tax return. No amendments shall be made to
Company’s income tax returns for the taxable years ending Year 1 and Year 2 with
respect to the tax imposed under § 1375. However, as an adjustment under
§ 1362(f)(4), Company must send payment of $b with a copy of this letter to the
following address:

PLR-133372-12 4

                            Internal Revenue Service
                            Cincinnati Service Center
                           201 West Rivercenter Blvd.
                              Covington, KY 41011
                                     Stop 31
                                   Terri Lackey
                                 Manual Deposit

    Company must send this payment no later than 45 days from the date of this

letter. If all the above conditions are not met, then this ruling is null and void.
Furthermore, if these conditions are not met, Company must send notification that its S
election has terminated to the service center with which Company’s S election was filed.

     Except as expressly provided herein, we express or imply no opinion concerning

the tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, we express or imply no opinion regarding Company’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 a power of attorney on file with this office, we are sending a

copy of this letter to your authorized representative.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

                                  Sincerely,



                                  Richard T. Probst
                                  Senior Technician Reviewer, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

Enclosures (2):

  A copy of this letter
  A copy for § 6110 purposes

cc: