PLR 1348009: IRS restores S corporation treatment after an inadvertent shareholder transfer

Plain-English summary

An S corporation unintentionally transferred its shares to an ineligible shareholder when purchase funds were sent to the wrong party. The parties later transferred the shares to the intended eligible shareholder. The corporation and its shareholders had consistently reported the corporation as an S corporation, and the IRS accepted that the mistake was not motivated by tax avoidance or retroactive planning. The IRS ruled that the S corporation election terminated on the transfer date but that the termination was inadvertent under IRC § 1362(f). It allowed the corporation to continue being treated as an S corporation from that date onward, subject to the stated eligibility conditions.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment after shares were inadvertently transferred to an ineligible shareholder?
• Outcome: approved
• Key authorities: IRC §§ 1361 and 1362, including §§ 1362(d)(2) and 1362(f)

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 201348009                                               Third Party Communication: None
Release Date: 11/29/2013                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                                Person To Contact:
----------------------------------------                        -----------------------, ID No. -------------------
--------------------------------                                ---------------------------------------------------
-----------------------------------------                       Telephone Number:
------------------------------                                  ----------------------
                                                                Refer Reply To:
                                                                CC:PSI:B02
                                                                PLR-129622-13
                                                                Date:
                                                                August 08, 2013

                                                       Legend

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

Y                          = --------------------------

Z                          = --------------------------
-----------------------------------------------------

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

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

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

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

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


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

      This responds to a letter dated June 20, 2013, and subsequent correspondence,
submitted on behalf of X by its authorized representative, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

       The information submitted states that X was formed in State on Date 1 and
elected to be treated as an S corporation effective on its formation. On Date 2, a
shareholder sold his shares to Y, a single member limited liability company treated as a
disregarded entity, owned by A, an eligible shareholder. The executed purchase
documents properly showed Y as the new shareholder. However, A erroneously

PLR-129622-13                       2

requested funds from Z and X shares were transferred to Z. Z is not an eligible
shareholder of X. The parties represent that Y was the intended shareholder.

       In Date 3, X learned of the termination of X’s S corporation election due to the
transfer of X shares to an ineligible shareholder for federal income tax purposes. In
Date 3, Z transferred the X shares to Y.

       X represents that X and each of its shareholders have filed consistently with the
treatment of X as an S corporation since Date 1. X further represents that the
inadvertent transfer of shares to Z rather than Y was not motivated by tax avoidance or
retroactive tax planning. 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(a)(1) of the Code 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 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 1361(c)(2)(A)(i) provides that, for purposes of § 1361(b)(1)(B), a trust all
of which is treated (under subpart E of part I of subchapter J of chapter 1) as owned by
an individual who is a citizen or resident of the United States may be an S corporation
shareholder.

       Section 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall
be terminated whenever (at any time on or after the first day of the first taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation, and (B) any termination under § 1362(d)(2) shall be effective on
and after the date of cessation.

        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 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 the
ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of
time after discovery of the circumstances resulting in the ineffectiveness or termination,
steps were taken (A) so that the corporation is a small business corporation, or (B) to
acquire the 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

PLR-129622-13                       3

corporation as an S corporation) as may be required by the Secretary with respect to
such period, then, notwithstanding the circumstances resulting in the ineffectiveness or
termination, the corporation will 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 election to be treated as an S corporation was terminated on Date 2 and that
this termination was inadvertent within the meaning of § 1362(f). We further conclude
that, pursuant to the provisions of § 1362(f), X will continue to be treated as being an S
corporation from Date 2 and thereafter, provided that X is otherwise eligible to be an S
corporation and provided that the election was not otherwise terminated under
§ 1362(d).

       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. Specifically, we express no opinion regarding X’s eligibility to be an S
corporation.

      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.

                                        Sincerely,



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




cc: