Corporation retained S status after a partnership briefly held its stock

Plain-English summary

An S corporation's election terminated when a partnership, which was not an eligible S corporation shareholder, acquired some of its stock. After discovering the error, the partnership transferred all of those shares to an eligible shareholder who had already owned company stock. The corporation represented that the mistake did not result from tax avoidance or retroactive planning, and the corporation and its shareholders agreed to any required adjustments. The IRS found the termination inadvertent and treated the corporation as continuously maintaining S status from the transfer date. The ruling did not otherwise decide whether the company qualified as an S corporation.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after an ineligible partnership temporarily became a shareholder?
• Outcome: Approved. The corporation was treated as continuing its S election from the termination date.
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1362-4(d)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201426011
Third Party Communication: None
Release Date: 6/27/2014
Date of Communication: Not Applicable
Index Numbers: 1362.00-00, 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-139654-13
Date:
February 3, 2014

LEGEND

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

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

A = --------------------------------------------------------------------------------------------------------------------
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State = --------

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

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

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

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

This letter responds to a letter dated August 21, 2013, and subsequent correspondence, submitted on behalf of Company by Company’s authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

Company incorporated in State on Date 1, and elected to be an S corporation effective Date 1. Before Date 2, eligible S corporation shareholders owned all of the stock of Company. On Date 2, however, Y, a partnership which is an ineligible S corporation shareholder under § 1361(b)(1)(B), acquired shares of Company. Upon discovery of this error, Y transferred all of its Company shares to A on Date 3. A is an
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eligible S corporation shareholder and has been a shareholder of Company since before Date 2.

Company represents that the circumstances resulting in the termination of Company’s S corporation election were not motivated by tax avoidance or retroactive tax planning. Company and its shareholders have agreed to make any adjustments consistent with the treatment of Company as an S corporation as may be required by the Secretary with respect to the period specified by § 1362(f).

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 such year.

Section 1361(b)(1)(B) provides that, for purposes of subchapter S, 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 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 1st taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation.

Section 1362(f) provides, in relevant 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 such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the circumstances resulting in the termination, the corporation will be treated as an S corporation during the period specified by the Secretary.

Section 1.1362-4(d) of the Income Tax Regulations provides, in part, that the Commissioner may require any adjustments that are appropriate. In general, the adjustments should be consistent with the treatment of the corporation as an S corporation during the period specified by the Commissioner.
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CONCLUSION

Based solely on the facts submitted and representations made, we conclude that Company’s S corporation election terminated on Date 2, when Company stock was transferred to Y, an ineligible shareholder. We further conclude that the termination was inadvertent within the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), Company will be treated as continuing to be an S corporation on and after Date 2, unless Company’s S corporation election is otherwise terminated under § 1362(d).

Except as expressly provided herein, we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express or imply no opinion regarding Company’s eligibility to be treated as an S corporation.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code 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 your authorized representative.

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,

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

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes

cc: