PLR 1345018: Inadvertent S corporation termination is cured after an ineligible trust transfer

Plain-English summary

A corporation elected S corporation status, but the election terminated when an ineligible trust received shares. The shares were later transferred to the trust's current income beneficiary, an eligible shareholder. The IRS ruled that the termination was inadvertent and that the corporation would be treated as an S corporation from the termination date onward, provided its election was not otherwise terminated. The ruling also required the corporation and its shareholders to make specified tax adjustments, including reporting pass-through items, adjusting basis, and accounting for distributions.

Ruling snapshot

• Question: Was the S corporation election termination inadvertent, allowing the corporation to retain S corporation treatment under IRC § 1362(f)?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368; Treas. Reg. § 1.1362-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201345018 Third Party Communication: None
Release Date: 11/8/2013 Date of Communication: Not Applicable
Index Numbers: 1362.00-00, 1362.04-00
Person To Contact:
---------------------------------- -----------------------, ID No. -------------------
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-------------------- Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-111630-13
Date:
July 11, 2013

                                              LEGEND

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

Trust = -------------------------------------------

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

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

Date = ------------------------
1
Date = ----------------------
2
Date = ------------------
3
Date = ----------------------
4

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

   This letter responds to a letter dated March 5, 2013, and subsequent

correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under § 1362(f) of the Internal Revenue Code.

                                               FACTS

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  X incorporated in State on Date 1, and elected to be an S corporation effective

Date 2. X’s S corporation election terminated on Date 3 when Trust, an ineligible S
corporation shareholder, received shares of X. As a corrective measure, on Date 4, the
shares of X held by Trust were transferred to A, the current income beneficiary of Trust
and an eligible S corporation shareholder.

   X represents that the circumstances resulting in the termination of X’s S

corporation election were inadvertent and were not motivated by tax avoidance or
retroactive tax planning. X and its shareholders have agreed to make any adjustments
consistent with the treatment of X 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 1361(b)(1)(B) provides that, for purposes of subchapter S, the term

"small business corporation" means a domestic corporation which is not an ineligible
corporation and which does not 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.

   Section 1362(d)(2)(A) provides that an election under § 1362(a) shall 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 relevant 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 the termination were inadvertent; (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
the 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 the period, then, notwithstanding the
circumstances resulting in the termination, the corporation will be treated as an S
corporation during the period specified by the Secretary.

   Section 1.1362-4(b) provides, in relevant part, that for purposes of § 1.1362-4(a),

the determination of whether a termination was inadvertent is made by the

PLR-111630-13 3

Commissioner. The corporation has the burden of establishing that under the relevant
facts and circumstances the Commissioner should determine that the termination was
inadvertent. The fact that the terminating event was not reasonably within the control of
the corporation and was not part of a plan to terminate the election, or the fact that the
terminating event or circumstance took place without the knowledge of the corporation,
notwithstanding its due diligence to safeguard itself against such an event or
circumstance, tends to establish that the termination was inadvertent.

   Section 1.1362-4(d) provides, in part, that the Commissioner may require any

adjustments that are appropriate. In general, the adjustments should be consistent with
the treatment of the corporation as an S corporation during the period specified by the
Commissioner.

                                 CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

the termination of X’s S corporation election on Date 3 was inadvertent within the
meaning of § 1362(f). Therefore, X will be treated as an S corporation effective Date 3
and thereafter, provided X’s S corporation election 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 stated computed items of X
as provided in § 1366, making any adjustments to basis as provided in § 1367, and
taking into account any distributions made by X as provided in § 1368. For this
purpose, A shall be treated as the shareholder of X with respect to the stock of X held
by Trust, beginning Date 3. If X or its shareholders fail to treat themselves as described
above, this letter ruling shall be null and void.

    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 whether X is
otherwise eligible to be treated as 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.

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   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,



                                 James A. Quinn
                                 Senior Counsel, Branch 3
                                 Office of the Associate Chief Counsel
                                 (Passthroughs & Special Industries)

Enclosures (2):

  Copy of this letter
  Copy for § 6110 purposes