IRS restores S corporation status after an inadvertent termination

Plain-English summary

The IRS considered an S corporation whose election terminated when its shares were transferred to an ineligible shareholder. The shares were later transferred back to the corporation, and the corporation requested relief under § 1362(f). The IRS found that the termination was inadvertent and treated the corporation as an S corporation from the termination date onward, provided the election was not otherwise terminated. The ruling required an adjustment, a payment of a redacted amount, and a copy of the ruling to be sent to the IRS within 120 days, or the relief would be void.

Ruling snapshot

• Question: Could the corporation receive relief after a transfer to an ineligible S corporation shareholder terminated its election?
• Outcome: Approved, S corporation status restored under § 1362(f), subject to conditions
• Key authorities: IRC §§ 1361, 1362, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201408012 Third Party Communication: None
Release Date: 2/21/2014 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.02-03
Person To Contact:
---------------------------------------- ----------------, ID No. ------------------
----------------------------------- Telephone Number:
------------------------------------ ----------------------
-------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-123011-13
Date:
October 23, 2013

LEGEND

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

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

D1 = ----------------------------

D2 = -------------------

D3 = ----------------------

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

$a = ------------

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

This responds to a letter dated April 10, 2013, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

FACTS
PLR-123011-13 2

According to the information submitted and representations within, X was incorporated
and elected to be treated as an S corporation on D1, under the laws of State.

On D2, X shares were transferred to Y. Y was an ineligible S corporation shareholder.
As a result, X’s S election terminated on D2. X and its shareholders took corrective
action and transferred the X shares from Y to X on D3.

X represents that neither it nor any of its shareholders intended to terminate X’s
Subchapter S election. In addition, X represents that other than the inadvertent
termination, X has qualified as a small business corporation at all times since D1. X
represents that its S corporation election termination was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. Further, X represents that X
and its shareholders agree to make any adjustments required as a condition of
obtaining relief under the inadvertent termination rule as provided under § 1362(f) of the
Code that may be required by the Secretary.

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 the year. Section 1361(b)(1) defines a “small business corporation” as a
domestic corporation which is not an ineligible corporation which 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 1
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 1st day of the taxable year for which the
corporation is an S corporation) such corporation ceases to be a small business
corporation.

Section 1362(f) provides in part that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d), (2) the Secretary determines that the
circumstances resulting in the termination were inadvertent, (3) no later than a
reasonable period of time after the 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 such corporation at any time
during the period of inadvertent termination of the S election, agrees to makes 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 the termination, the corporation is treated as an S corporation
during the period specified by the Secretary.
PLR-123011-13 3

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
X’s corporation election terminated on D2. However, we further conclude that the
termination was inadvertent within the meaning of § 1362(f). Therefore, X will be
treated as an S corporation effective D2 and thereafter, provided X’s S corporation
election is not otherwise terminated under § 1362(d).

This letter ruling is subject to the following condition: An adjustment under § 1362(f)(4),
a payment of $a and a copy of this letter must be sent to the following address: Internal
Revenue Service, Cincinnati Service Center, 201 West Rivercenter Blvd., Covington,
KY 41011, Stop 31, Terri Lackey, Manual Deposit. This payment must be sent no later
than 120 days from the date of this letter. If this condition is not met, then this ruling is
null and void. Furthermore, if this condition is not met, X must send notification that its
S election has terminated to the service center with which X’s S election was filed.

Except as specifically ruled upon above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be 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 the power of attorney on file with this office, a copy of this letter is
being sent to the taxpayer’s authorized representative.

                                    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

cc: