Transfers to ineligible shareholders caused an inadvertent S termination

Plain-English summary

An S corporation transferred shares to two ineligible shareholders, terminating its election, but later moved those shares to eligible shareholders. The corporation represented that no one intended the termination, it was not motivated by tax avoidance or retroactive planning, and all affected parties would make required adjustments. The IRS treated the termination as inadvertent under § 1362(f), allowing the corporation to retain S status throughout the affected period if its election was otherwise valid.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after shares were held by ineligible S corporation shareholders?
• Outcome: Approved. The corporation was treated as an S corporation during and after the affected period.
• Key authorities: IRC §§ 1361 and 1362(d), (f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201432006
Third Party Communication: None
Release Date: 8/8/2014
Date of Communication: Not Applicable
Index Number: 1362.02-00, 1362.02-02,
1362.04-00
Person To Contact:
--------------, ID No. ----------------
------------------------------------
Telephone Number:
----------------------------------------- --------------------
------------------
Refer Reply To:
---------------------------
CC:PSI:B01
PLR-143947-13
Date:
March 28, 2014

LEGEND

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

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

Z = -------------------------------------------------------
------------------------------------------

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

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

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

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

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

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

This responds to a letter dated October 21, 2013, submitted on behalf of X by X’s authorized representative, requesting relief under section 1362(f) of the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations within, X was incorporated on Date 1, under the laws of State. Effective Date 1, X elected to be treated as an S corporation.

On Date 2, shares of X were transferred to Y. Y was an ineligible S corporation shareholder. As a result, X’s S corporation election terminated on Date 2. In addition, on Date 3, X shares were transferred to Z. Z was an ineligible S corporation shareholder. X and its shareholders took corrective action and transferred the X shares from Y and Z to eligible shareholders on Date 4.

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 Date 2. 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.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that X’s S corporation election terminated on Date 2. 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 Date 2 and thereafter, provided X’s S corporation election is otherwise valid and is not otherwise terminated under § 1362(d).

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,

Joy C. Spies
Joy C. Spies
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: