PLR 1325003: IRS restores S corporation status after an inadvertent transfer to an ineligible shareholder

Plain-English summary

An LLC that had elected S corporation status issued interests to a shareholder who was not eligible to own S corporation stock. The IRS concluded that the S corporation election terminated when the transfer occurred, but that the termination was inadvertent and not tax-motivated. Because corrective steps restored eligible ownership, the IRS treated the entity as an S corporation from the termination date onward, subject to the election otherwise remaining valid. The shareholders also had to report pass-through items, adjust basis, and account for distributions consistently with the S corporation rules.

Ruling snapshot

• Question: Could the entity receive relief under section 1362(f) after an inadvertent transfer to an ineligible S corporation shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1362, 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201325003 Third Party Communication: None
Release Date: 6/21/2013 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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-------------------------------- Refer Reply To:
CC:PSI:B2
PLR-139011-12
Date: March 7, 2013

X = ------------------------------------------------------------------------------------------------------
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Y = ------------------------------------------------------------------------------------------------------
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A = ------------------------------------------------------------------------------------------------------
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B = ---------------------------

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D4 = --------------

D5 = -----------------

Dear -------------------

    This responds to a letter dated August 29, 2012, and subsequent

correspondence, submitted on behalf of X by X’s authorized representative, requesting
relief under § 1362(f) of the Internal Revenue Code.
PLR-139011-12 2

   The information submitted states that X was formed as a Limited Liability

Company under the laws of State on D1 and elected to be an S corporation effective
D2. In D3, X issued interests to Y, an ineligible S corporation shareholder for federal
income tax purposes. Therefore, X’s S corporation election terminated in D3. About
D4, X learned of the termination of X’s S corporation election due to the transfer of X
interests to an ineligible shareholder for federal income tax purposes. In D5, steps were
taken so that X again became a small business corporation owned solely by A and B
consistent with their X ownership prior to the D3 transfer of X interests to Y.

   X represents that the circumstances resulting in X’s invalid S corporation election

were inadvertent and not motivated by tax avoidance or retroactive tax planning. X
further represents that X has filed returns consistent with X’s status as an S corporation.
X and its shareholders have agreed to make such adjustments (consistent with the
treatment of X as an S corporation) as may be required by the Secretary.

    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
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 facts submitted and the representations made, we conclude

that X’s S corporation election was terminated on D3 because Y was not an eligible
shareholder of X. We also conclude that the termination of X’s S election in D3 was
inadvertent within the meaning of § 1362(f). Therefore, we conclude that X will be
treated as an S corporation from D3 and thereafter, provided that X’s S corporation
election was otherwise valid and was not otherwise terminated under § 1362(d).

   This ruling is conditioned upon the shareholders of X including in income their

pro rata share of the separately stated and nonseparately computed items of X as
provided in § 1366, making any adjustments to basis as provided by § 1367, and taking
into account any distributions made by X as provided by § 1368.
PLR-139011-12 3

   Except as specifically set forth above, no opinion is expressed or implied

concerning the federal tax consequences of the facts described above under any other
provision of the Code. Specifically, no opinion is expressed regarding X’s eligibility to
be an S corporation.

  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 a power of attorney on file with this office, a copy of this letter is

being sent to X's authorized representative.

                                    Sincerely,




                                    Charlotte Chyr
                                    Senior Technician Reviewer, Branch 2
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes