S corporation receives relief for an inadvertent termination

Plain-English summary

An S corporation transferred shares to an ineligible shareholder, causing its S election to terminate. After discovering the problem, the parties returned the shares to the original shareholders and liquidated the ineligible shareholder. The corporation represented that the mistake was not tax-motivated, that it and its shareholders had continued filing consistently as an S corporation, and that they would make any required adjustments. The IRS found the termination inadvertent under IRC § 1362(f). It therefore treated the corporation as continuing to be an S corporation from the termination date forward, provided the election was not otherwise terminated.

Ruling snapshot

• Question: Did the transfer of shares to an ineligible shareholder qualify for inadvertent S election termination relief?
• Outcome: Approved
• Key authorities: IRC §§ 1361 and 1362(f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201452014
Third Party Communication: None
Release Date: 12/26/2014
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Refer Reply To:
CC:PSI:B01
PLR-119511-14
Date:
September 08, 2014

LEGEND

X = -----------------------------------
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Y = ---------------------------------
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Date 1 = -----------------

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

State 1 = ------------

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

This responds to a letter dated May 8, 2014, 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 made within, X was incorporated on Date 1 and made a valid S election effective Date 1, under the laws of State 1.

On Date 2 a number of shares of X were transferred to Y, an ineligible shareholder, thus causing a termination of X’s S election. After the discovery of the terminating event, X

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and its shareholders took corrective action. Y distributed all of its X shares to the original shareholders and then Y liquidated.

X represents that if its S corporation election terminated it was inadvertent and was not motivated by tax avoidance or retroactive tax planning. X also 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. X further represents that X and its shareholders have filed consistently with X continuing to be a valid S corporation.

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, and a trust described in subsection (c)(2), or an organization described in subsection (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 because X had an ineligible shareholder. However, we conclude that the termination was inadvertent within the

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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 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.

Pursuant to the power of attorney on file with this office, we are sending a copy of this letter to your authorized representative.

Sincerely,

Laura C. Fields
Laura C. Fields
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: