PLR 1341014: IRS restores S corporation status after an inadvertent termination

Plain-English summary

The IRS ruled that a corporation's disproportionate and corrective distributions did not create a second class of stock because its governing documents gave all shares identical distribution and liquidation rights. The corporation's S corporation election did terminate when three trusts were not permissible shareholders because required qualified subchapter S trust elections had not been filed. The IRS found that termination inadvertent and treated the corporation as an S corporation again from the termination date, provided its election was not otherwise terminated. The relief required the shareholder to file the three trust elections with the termination date as their effective date within 120 days after the ruling. The IRS did not rule on the trusts' qualification or the corporation's other S corporation requirements.

Ruling snapshot

• Question: Did the distributions create a second class of stock, and can the corporation receive relief after its S corporation election terminated because of ineligible shareholders?
• Outcome: Approved
• Key authorities: IRC §§ 1361(b)(1), 1362(d), 1362(f), and 6110(k)(3); Treas. Reg. §§ 1.1361-1(l)(1) and 1.1361-1(l)(2)(i)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201341014 Third Party Communication: None
Release Date: 10/11/2013 Date of Communication: Not Applicable
Index Number: 1361.01-04, 1362.04-00
Person To Contact:
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-------------------------------------- Telephone Number:
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--------------------- Refer Reply To:
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PLR-102459-13
Date:
June 24, 2013

LEGEND:

X = ----------------------------------------------------------------------------------------------------------------------
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A = ------------------------

B = -------------------------------------------------------------------------------------------------------------

Trust = ----------------------------------------------------------------------------------------------------------------------
1 ----------------------------------------------------------------------------------------------------------------------
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Trust = ----------------------------------------------------------------------------------------------------------------------
2 ----------------------------------------------------------------------------------------------------------------------
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Trust = ----------------------------------------------------------------------------------------------------------------------
3 ----------------------------------------------------------------------------------------------------------------------
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Trust = ----------------------------------------------------------------------------------------------------------------------
4 ------------------------------------------------

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

D1 = ----------------------

D2 = ----------------------
PLR-102459-13 2

D3 = --------------------

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

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

D6 = ------------------------

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

This responds to a letter dated December 19, 2012, submitted on behalf of X by its
authorized representative, requesting a ruling under the Internal Revenue Code.

The information submitted states that X was incorporated under the laws of State on
D1, and elected to be an S corporation effective D2.

At the time of the S election, all of the shares of X stock were held equally by A and B,
husband and wife, until A died on D3. On D4, following the administration of A’s estate,
A’s estate distributed its shares of X to Trust 1, Trust 2, and Trust 3. Additionally on
D4, B contributed B’s shares to Trust 4, a grantor trust.

X represents that Trust 1, Trust 2, and Trust 3 were qualified subchapter S trusts
(QSSTs) eligible to make an election under § 1361(d)(2) effective D5. During the two
years between D4 and D5, Trust 1, Trust 2, and Trust 3 were eligible shareholders by
reason of § 1361(c)(2)(A)(iii). However, no QSST elections were filed on behalf of Trust
1, Trust 2, or Trust 3. Therefore, Trust 1, Trust 2, and Trust 3 were not permissible
shareholders, and X’s S corporation election terminated on D5.

Beginning D4, X made disproportionate distributions among its shareholders, Trust 1,
Trust 2, Trust 3, and Trust 4. X represents that the failure to make pro rata distributions
to its shareholders was inadvertent. After X learned of this failure, X made corrective
distributions to Trust 1, Trust 2, and Trust 3 on or before D6, thus eliminating the
cumulative amount of the disproportionate distributions.

X represents that the termination was not motivated by tax avoidance or retroactive tax
planning. X further represents that from D5, X and its shareholders have filed all returns
consistent with X’s status as an S corporation. X and its shareholders have agreed to
make any adjustments that the Commissioner may require, consistent with the
treatment of X as an S corporation.

Section 1361(b)(1) provides for purposes of subchapter S, 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
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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 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) 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 § 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 shareholders 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.

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.

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.

Based solely on the facts submitted and representations made, we conclude that
because X’s stock has identical distribution and liquidation rights under its governing
provisions, the difference in timing between X’s disproportionate distributions to some of
the shareholders and X’s corrective distributions to certain shareholders do not cause X
to have more than one class of stock for purposes of § 1361(b)(1)(D). However, such
disproportionate and corrective distributions must be given appropriate tax effect.
PLR-102459-13 4

Under these circumstances, we conclude that X’s S corporation election did not
terminate because of the disproportionate and corrective distributions to the
shareholders.

Additionally, based solely on the facts submitted and the representations made, we
conclude that X’s S corporation election terminated on D5 because Trust 1, Trust 2, and
Trust 3 were not eligible shareholders of X. We further conclude that the termination of
X’s S corporation election on D5 was inadvertent within the meaning of § 1362(f).
Therefore, X, will be treated as an S corporation effective D5 and thereafter, provided
X’s S corporation election is not otherwise terminated under § 1362(d).

This ruling is conditioned upon B filing QSST elections for Trust 1, Trust 2, and Trust 3,
respectively, with an effective date of D5 within 120 days of the date of this ruling. A
copy of this letter should be attached to each election.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed regarding X’s eligibility to be an S
corporation or the validity of its S corporation election. No opinion is expressed as to
whether Trust 1, Trust 2, or Trust 3 qualifies as a QSST or whether any other
shareholder of X is a permissible S corporation shareholder.

The rulings contained in this letter are 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 request for rulings, it is subject to verification on examination.

This ruling is directed 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 forwarded to X’s authorized representative.

                                   Sincerely,

                                   Bradford R. Poston
                                   Senior Counsel, Branch 2
                                   (Passthroughs & Special Industries)

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