Early replacement S corporation election denied

Plain-English summary

An S corporation asked for permission to make a new S election before the five-year waiting period following termination of its prior election. The corporation had transferred shares to an ineligible shareholder after a regulator denied permission to make distributions, which terminated the prior election. The IRS concluded that the termination resulted from a business decision within the control of the corporation and its shareholders. Because the facts did not support an exception to the waiting period in IRC § 1362(g), the IRS denied consent to make a new election early.

Ruling snapshot

• Question: Could the corporation make a new S election before the five-year period after its prior election terminated?
• Outcome: Denied.
• Key authorities: IRC §§ 1362(g) and 6110(k)(3); Treas. Reg. § 1.1362-5(a); Rev. Rul. 78-275.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201403001 Third Party Communication: None
Release Date: 1/17/2014 Date of Communication: Not Applicable
Index Number: 1362.01-03, 9100.00-00
Person To Contact:
-------------------------------- ----------------, ID No. ------------------
--------------------------------------------------------- Telephone Number:
--------------------------------- ----------------------
----------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-113370-13
Date:
September 17, 2013

LEGEND

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

Regulator = -----------------------------------------------------

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

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

Year 1 = -------

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

This responds to a letter dated March 15, 2013, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative requesting permission for X to
make a new S election prior to the expiration of the five-year period specified in section
§ 1362(g) of the Internal Revenue Code.

According to the information submitted, X indicated that it filed an election to be treated
as an S corporation effective for its tax year beginning Date 1. In Year 1, the Regulator
and X agreed that X would not make distributions without prior approval from Regulator.
Regulator denied X’s request to make distributions. X then made a business decision to
transfer X shares to an ineligible shareholder to terminate its X election effective Date 2.
Furthermore, there has not been a more than 50 percent ownership change in X since
its S election terminated.

PLR-113370-13 2

Section 1362(g) provides that, if a small business corporation has made an election
under §1362(a) and if such election has been terminated under § 1362(d), such
corporation (and any successor corporation) shall not be eligible to make an election
under subsection (a) for any taxable year before its 5th taxable year which begins after
the 1st taxable year for which such termination is effective, unless the Secretary
consents to such election.

Section 1.1362-5(a) of the Income Tax Regulations provides that the corporation has
the burden of establishing that under the relevant facts and circumstances, the
Commissioner should consent to a new election. The fact that more than 50 percent of
the stock in the corporation is owned by persons who did not own any stock in the
corporation on the date of the termination tends to establish that consent should be
granted. In the absence of this fact, consent ordinarily is denied unless the corporation
shows that the event causing termination was not reasonably within the control of the
corporation or the shareholders having a substantial interest in the corporation and was
not part of a plan of the corporation or of such shareholders to terminate the election.

In Revenue Ruling 78-275, 1978-2 C.B. 221, an election by a small business
corporation engaged in the business of acquiring, developing, and subdividing land for
sale to residential home builders, was automatically terminated when interest income
exceeded 20 percent of its gross receipts. Pursuant to a credit agreement with a bank,
the corporation was required to maintain a time deposit in the same bank. Interest
income exceeded allowable amounts because the depressed economic state of the
home construction industry prevented the corporation from realizing income from its
operations. As a result, because the events that caused the termination were not
reasonably within the control of the shareholders and were not part of a plan to
terminate the election, the corporation was granted permission to make a new election
prior to the expiration of the five-year period.

Unlike the situation in Revenue Ruling 78-275, X terminated its subchapter S election.
X made a business decision to terminate its S election when Regulator did not grant X
permission to make any distributions. Accordingly, X is denied consent to make a new
subchapter S election prior to the termination of the five-year period required by section
1362(g) of the Code.

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.

PLR-113370-13 3

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.

                                  Sincerely,




                                  Laura C. Fields
                                  Laura C. Fields
                                  Senior Technician Reviewer, Branch 1
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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