PLR 1348001: IRS preserves S corporation and QSub status after an inadvertent invalid election

Plain-English summary

A corporation elected S corporation status even though some of its shares were held by individual retirement accounts, which are ineligible S corporation shareholders under the Code. The corporation later corrected the ownership by distributing some shares to IRA beneficiaries and redeeming the remaining IRA-held shares. The IRS ruled that the S corporation election was invalid but that the invalidity was inadvertent under IRC § 1362(f). It allowed the corporation to be treated as an S corporation from the original effective date and allowed its subsidiary to be treated as a qualified subchapter S subsidiary from its stated effective date, subject to conditions governing shareholder reporting and amended returns.

Ruling snapshot

• Question: Could the corporation and its subsidiary retain S corporation and QSub treatment after an inadvertent invalid S corporation election caused by IRA shareholders?
• Outcome: approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201348001                                             Third Party Communication: None
Release Date: 11/29/2013                                      Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.04-00
                                                              Person To Contact:
--------------------------------------------------            ----------------------, ID No. -----------------
-----------------------------                                 Telephone Number:
-------------------------------                               ---------------------
 ------------------------------                               Refer Reply To:
                                                              CC:PSI:B03
                                                              PLR-102082-13
                                                              Date:
                                                              July 29, 2013


                                                     LEGEND


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

Sub         =     ---------------------------------------------------------------------------------------------------------------------
                  ---------------------------

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

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

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

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

Date 4      =     ---------------------------

Date 5      =     ---------------------------


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

       This letter responds to a letter dated December 31, 2012, and subsequent
correspondence, written on behalf of X, requesting a ruling under § 1362(f) of the
Internal Revenue Code.
PLR-102082-13                               2



                                         Facts

        The information submitted states that X was incorporated under the laws of State
and made an election to be treated as an S corporation effective Date 1. On Date 2, X
purchased all of the outstanding shares of Sub and made an election to treat Sub as a
qualified subchapter S subsidiary (QSub) effective Date 3.

       X’s election was inadvertently invalid on Date 1 because shares of X stock were
owned by individual retirement accounts (“IRAs”), ineligible shareholders under
§ 1361(c)(2)(A). On Date 4, certain IRAs distributed their stock in X to their
beneficiaries and on Date 5 X redeemed the remaining IRA shareholders stock.

       X represents that the invalid election was not motivated by tax avoidance or
retroactive tax planning. X and its shareholders agree to make any adjustments that the
Commissioner may require, consistent with the treatment of X as an S corporation.

                                   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 that is not an ineligible
corporation and that does not, among other requirements, 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(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
PLR-102082-13                                3

specified by the Secretary.

                                       Conclusion

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election on Date 1 was invalid, and thus not effective. We
conclude that this ineffective election was inadvertent within the meaning of § 1362(f).
We further conclude that the ineffective S corporation election was inadvertent within
the meaning of § 1362(f).

       Under the provisions of § 1362(f), X will be treated as making a valid S
corporation election effective from Date 1 and thereafter, provided that X’s S corporation
election was otherwise valid and has not otherwise terminated under § 1362(d). In
addition, Sub will be treated as a QSub from Date 3 and thereafter, provided that Sub’s
QSub election was otherwise valid and has not otherwise terminated.

       As a condition for this ruling, for any tax periods between Date 1 and Date 5 in
which X reported a net loss, IRAs will be treated as the shareholders of the shares of
stock IRAs held at that time. For any tax periods between Date 1 and Date 5 in which X
reported a net gain, the IRA beneficiaries will be treated as the shareholders of the
shares of stock held by IRAs. All of X’s shareholders, in determining their respective
income tax liabilities during the termination period and thereafter, must include their pro
rata share of the separately stated items of income (including tax-exempt income), loss,
deduction, or credit and non-separately stated computed items of income or loss of X as
provided in § 1366, make any adjustments to basis provided in § 1367, and take into
account any distributions made by X as provided in § 1368. Additionally, for tax periods
between Date 1 and Date 5, X’s shareholders agree to amend their tax returns and treat
pending refund requests consistent with the treatment described above. If X or its
shareholders fail to treat themselves as described above, this ruling shall be null and
void.

       Except as specifically ruled above, we express no opinion concerning the federal
tax consequences of the transactions described above under any other provisions of the
Code, including whether X was or is a small business corporation under § 1361(b) or
whether Sub is otherwise eligible to be a QSub.
PLR-102082-13                                4



        This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent. Pursuant to a power of attorney
on file, a copy of this letter is being sent to X’s authorized representatives.

       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,




                                      Stacy L. Short
                                      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



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