Ineligible shareholder caused inadvertent S election termination

Plain-English summary

The IRS ruled that an S corporation's election terminated when an ineligible shareholder acquired its stock, but that the termination was inadvertent under IRC § 1362(f). The corporation represented that the event was not motivated by tax avoidance or retroactive planning, that it and its shareholders consistently filed as though S status continued, and that all parties would make any required adjustments. The corporation would therefore be treated as continuing its S status from the termination date forward, unless the election was otherwise terminated.

Ruling snapshot

• Question: Can an S corporation retain its status after an ineligible shareholder temporarily caused its election to terminate?
• Outcome: Approved. The termination was inadvertent, and S status was treated as continuing.
• Key authorities: IRC §§ 1361 and 1362(d), (f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201421004
Third Party Communication: None
Release Date: 5/23/2014
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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-------------------------------------------- Telephone Number:
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Refer Reply To:
CC:PSI:03
PLR-137163-13

January 30, 2014

LEGEND

X = ------------------------------------------------------------------------------------------------------
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D1 = ----------------------------

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

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

D4 = ------------------

State = ---------

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

This letter responds to a letter dated August 1, 2013, and subsequent correspondence, submitted on behalf of X by its authorized representative requesting a ruling under § 1362(f) of the Internal Revenue Code (“Code”).

FACTS

X was incorporated under the laws of State on D1 and elected to be an S corporation effective D2. Between D3 and D4, an ineligible S corporation shareholder owned shares of X stock and, therefore, X’s S corporation election terminated on D3.

X represents that the termination was not motivated by tax avoidance or retroactive tax planning. X further represents that X and its shareholders have filed consistently with the treatment of X as an S corporation since D2. X and its
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shareholders have agreed to make any adjustments that the Commissioner may require, consistent with the treatment of X as an S corporation.

LAW AND ANALYSIS

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

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) provides that the term “small business corporation” means a domestic corporation which is not an ineligible corporation and 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 one class of stock.

Section 1362(d)(2)(A) provides that an election under § 1362(a) will 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 part, that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that the circumstances resulting in the termination were inadvertent; (3) no later than a reasonable period of time after 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 the corporation at any time during the period specified pursuant to § 1362(f), agrees to make the 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 shall be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that X’s S corporation election terminated on D3 because X had an ineligible shareholder. However, we conclude that the termination was inadvertent within the meaning of § 1362(f). Consequently, we rule that X will be treated as continuing to be
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an S corporation from D3 and thereafter, provided that X’s S corporation election is not otherwise terminated under § 1362(d).

Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the facts described above under any other provisions of the Code, including whether X was otherwise a valid 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.

In accordance with a power of attorney on file with this office, we are sending a copy of this letter to X’s authorized representative.

Sincerely,

Mary Beth Carchia
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes