Repeated transfers to an ineligible shareholder were inadvertent S terminations

Plain-English summary

An S corporation twice transferred shares to an ineligible shareholder because its owners did not know the shareholder was prohibited from holding S corporation stock. After discovering the problem, the shares were transferred to an eligible owner. The IRS found the initial termination inadvertent under § 1362(f) and treated the corporation as continuously maintaining S status from that date, notwithstanding the later transfer, provided all affected parties consistently reported it as an S corporation.

Ruling snapshot

• Question: Could the corporation retain continuous S status after two transfers to an ineligible shareholder?
• Outcome: Approved. The termination was inadvertent and continuous S treatment was allowed subject to consistent reporting.
• Key authorities: IRC §§ 1361 and 1362(d), (f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201432001 Third Party Communication: None
Release Date: 8/8/2014 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------------ ----------------, ID No. ------------
------------------------------------- Telephone Number:
------------------------------------------------ --------------------
--------------------------------- Refer Reply To:
CC:PSI:B01
In Re: ------------------------------------ PLR-107199-14
Date:
April 23, 2014

LEGEND

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

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

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

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

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

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

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

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

This responds to a letter dated February 13, 2013, submitted on behalf of X by X’s
authorized representative, requesting inadvertent S corporation election termination
relief pursuant to § 1362(f) of the Internal Revenue Code.

                                                 FACTS

According to the information submitted and representations within, X incorporated under
the laws of State and elected to be treated as an S corporation effective Date 1. X’s S
corporation election terminated when it transferred shares of X to A, an ineligible
shareholder, on Date 2 and again on Date 3. On Date 4, X discovered that it had

effectively terminated its S corporation election and took corrective action; the shares of
X were transferred to A’s owner, an eligible shareholder. X represents that its
shareholders were unaware that A was prohibited from owning shares of X, and that
such a transaction would terminate X’s S corporation election. X also represents that its
shareholders did not intend to terminate X’s S corporation election.

                                      LAW

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)(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) 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, and that any termination under § 1362(d)(2) shall be effective on and after
the date of cessation.

Section 1362(f) provides, in part, that if -- (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2); (2) the Secretary determines that the
circumstances resulting in such termination were inadvertent; (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, or to acquire the required shareholder consents; 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 specified pursuant to §
1362(f), agrees to make such adjustments (consistent with the treatment of such
corporation as an S corporation) as may be required by the Secretary with respect to
such period, then, notwithstanding the circumstances resulting in such termination, such
corporation shall be treated as an S corporation during the period specified by the
Secretary.

                                 CONCLUSION

Based solely upon the facts submitted and the representations made, we conclude that
X’s S corporation election terminated when it transferred shares of X to A, an ineligible
shareholder, on Date 2. We further conclude that the termination of X’s S corporation
election constituted an inadvertent termination within the meaning of § 1362(f). Under §
1362(f), X will be treated as an S corporation from Date 2 and thereafter,
notwithstanding the transfer on Date 3 (the subsequent transfer on Date 3 will not
preclude X from being treated as an S corporation from Date 2), provided that X’s S
corporation election was otherwise valid and has not otherwise terminated under §
1362(d). This ruling is contingent upon X and all its shareholders treating X as having
been an S corporation for the period beginning Date 2 and thereafter, once again,
notwithstanding the transfer on Date 3.

Except as specifically ruled upon above, no opinion is expressed as to the federal
income tax consequences of the facts described above under any other provision of the
Code, including whether X was otherwise eligible to be an S corporation or whether the
shareholders of X were otherwise eligible S corporation shareholders.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent. In accordance with the
Power of Attorney on file with this office, copies of this letter ruling will be sent to your
authorized representatives.

                                              Sincerely,


                                              David R. Haglund
                                              David R. Haglund
                                              Branch Chief, Branch 1
                                              Office of the Associate Chief Counsel
                                              (Passthroughs & Special Industries)

Enclosures (2)

   Copy of this letter.
   Copy of this letter for §6110 purposes.

cc: