Partnership's temporary ownership was inadvertent S termination

Plain-English summary

An individual intended to buy all shares of an S corporation using financing supplied by a partnership. The partnership inadvertently became the shareholder for a period before transferring the shares to the individual. Because a partnership is not a permitted S corporation shareholder, the election terminated when that ownership began. The company represented that the mistake was not tax-motivated, that it and the shareholder consistently filed as though S status continued, and that they would accept required adjustments. The IRS treated the termination as inadvertent and allowed the corporation to remain an S corporation continuously, assuming its election was otherwise valid.

Ruling snapshot

• Question: Could an S corporation retain continuous status after a financing partnership temporarily and inadvertently became its shareholder?
• Outcome: Approved as an inadvertent termination under § 1362(f)
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1362-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201448005 Third Party Communication: None
Release Date: 11/28/2014 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
----------------------- --------------------------, ID No. -------------
-------------------------------------------------- Telephone Number:
------------------------------------------ ---------------------
-------------------------------- Refer Reply To:
CC:PSI:03
PLR-108993-14
Date:
August 12, 2014

LEGEND

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

Shareholder = ----------------------------------------------------------------------------------------------------------------
--------------

Partnership = ----------------------------------------------------------------------------------------------------------------
-------------

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

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

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

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

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

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

   This letter responds to a letter dated March 4, 2014, and subsequent

correspondence, submitted on behalf of X by its authorized representative requesting a
ruling under § 1362(f) of the Internal Revenue Code.

                                                 FACTS

  X was incorporated under the laws of State on D1 and elected to be an S

corporation effective D2. On D3, Shareholder intended to purchase all of the shares of
X stock, with financing provided by Partnership. However, Partnership inadvertently
PLR-108993-14 2

became a shareholder in X until D4, at which time Partnership transferred its shares to
Shareholder. Partnership was not a permitted shareholder 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 Shareholder have filed
consistently with the treatment of X as an S corporation since D3. X and Shareholder
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 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 (A) so that the corporation is a small business
corporation, and (4) the corporation and each person who was a shareholder of 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 such 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.
PLR-108993-14 3

   Section 1.1362-4(b) provides, in relevant part, that for purposes of § 1.1362-4(a),

the determination of whether a termination was inadvertent is made by the
Commissioner. The corporation has the burden of establishing that under the relevant
facts and circumstances the Commissioner should determine that the termination was
inadvertent. The fact that the terminating event was not reasonably within the control of
the corporation or was not part of a plan to terminate the election, or the fact that the
terminating event or circumstance took place without the knowledge of the corporation,
notwithstanding its due diligence to safeguard itself against such an event or
circumstance, tends to establish that the termination was inadvertent.

   Section 1.1362-4(d) 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.

                                 CONCLUSION

   Based solely on the facts submitted and the representations made, we conclude

that X’s S corporation election terminated on D3. We also conclude that the
circumstances resulting in the termination were inadvertent within the meaning of
§ 1362(f). Accordingly, under § 1362(f), X will be treated as an S corporation from D3
and thereafter, provided X’s S corporation election was otherwise valid and has not
otherwise terminated under § 1362(d).

   Except as specifically ruled above, we express no opinion concerning the federal

tax consequences of the facts described above under any other provisions of the Code.
Specifically, we express no opinion regarding X’s eligibility to be an 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.
PLR-108993-14 4

  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,



                                 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: