IRS restores S corporation status after a delayed shareholder redemption

Plain-English summary

The IRS considered a corporation whose S corporation election became ineffective because a foreign corporation remained a shareholder longer than intended. The corporation had negotiated a redemption but did not complete it until after the intended S corporation effective date. The IRS found that the failure was inadvertent and treated the company as an S corporation from that effective date onward, provided the election was otherwise valid and not later terminated. The ruling did not address the company's other eligibility requirements.

Ruling snapshot

• Question: Could the company receive relief after an ineligible shareholder caused its S corporation election to become ineffective?
• Outcome: Approved, S corporation status restored under § 1362(f)
• Key authorities: IRC §§ 1361, 1362, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201408011 Third Party Communication: None
Release Date: 2/21/2014 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
------------------------------------------ ----------------------, ID No. ------------------
-------------------------------- Telephone Number:
--------------------------------- ----------------------
-------------------------------- Refer Reply To:
CC:PSI:B03
PLR-121975-13
Date:
September 30, 2013

                                               LEGEND

Company = --------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

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

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

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

   This letter responds to a letter dated April 22, 2013, submitted on behalf of

Company by its authorized representative, requesting a ruling under § 1362(f) of the
Internal Revenue Code.

                                                FACTS

   According to the information submitted, Company was incorporated under State

law on Date 1. On Date 2, Company was actively engaged in negotiations to buy out a
foreign corporation shareholder. Company’s remaining shareholders were A and B, two
individuals who qualified to be S corporation shareholders. Company elected to be an
S corporation effective Date 3. The redemption agreement for the foreign corporation
PLR-121975-13 2

shareholder was not signed, however, until Date 4, even though the parties intended for
A and B to be the only shareholders of Company on Date 3. Therefore, between Date 3
and Date 4, Company had an ineligible S corporation shareholder and terminated
inadvertently Company's S corporation election.

   Company represents that for all years, Company and its eligible shareholders

have filed all Federal income tax returns consistent with Company’s S corporation
election. In particular, Company treated A and B as its only shareholders for
Company’s tax year beginning Date 3. Company represents that the termination was
not motivated by tax avoidance or retroactive tax planning. Company and its
shareholders have agreed to make any adjustments that the Commissioner may
require, consistent with the treatment of Company as an S corporation.

                              LAW AND ANALYSIS

  Section 1361(a)(1) defines an “S corporation” as a small business corporation for

which an election under § 1362(a) is in effect for the taxable year.

   Section 1361(b)(1) defines a “small business corporation” as a domestic

corporation that is not an ineligible corporation and that 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 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(d)(2)(A) provides that 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.

   Section 1362(f) provides, in pertinent part, that if an election under § 1362(a) by

any corporation 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, (2) the Secretary determines that the
circumstances resulting in such ineffectiveness were inadvertent, (3) no later than a
reasonable period of time after discovery of the event resulting in the ineffectiveness,
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, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

                                  CONCLUSION

PLR-121975-13 3

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

Company’s S corporation election effective Date 3 was ineffective because Company
had an ineligible shareholder. We also conclude that Company’s ineffective S
corporation election was inadvertent within the meaning of § 1362(f). Accordingly,
under § 1362(f), Company will be treated as an S corporation from Date 3 and
thereafter, provided that Company’s S corporation election was otherwise valid and was
not terminated under § 1362(d).

   Except as expressly provided herein, we express or imply no opinion concerning

the Federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, we express or imply no opinion concerning
whether Company is otherwise eligible to be an S corporation for Federal tax purposes.

  In accordance with a power of attorney on file with this office, we are sending a

copy of this letter to Company’s authorized representatives.

  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.

   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,

                                  /s/

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

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

cc: