S corporation receives relief after shares briefly pass to an ineligible owner

Plain-English summary

An S corporation’s shareholders placed their shares in two revocable trusts, then some shares were transferred to an owner that was not eligible to hold S corporation stock. That transfer terminated the corporation’s S election. After discovering the problem, the parties returned all affected shares to the trusts. The corporation represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive planning, and that all parties had continued filing consistently with S corporation status. The IRS granted relief under section 1362(f) and treated the corporation as an S corporation throughout the termination period, provided its election was not otherwise terminated.

Ruling snapshot

• Question: Could an S corporation keep its status after shares were inadvertently transferred to an ineligible shareholder?
• 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: 201511016 Third Party Communication: None
Release Date: 3/13/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------------------- ----------------, ID No. ------------------
------------------------------------------------- Telephone Number:
--------------------------------- ----------------------
--------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-124417-14
Date:
November 04, 2014

LEGEND

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

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

Trust A = -----------------------------------------------------------------------------------------

                       --------------------------

Trust B = -----------------------------------------------------------------------------------------

--
--------------------------

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

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

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

Year 1 = -------

State = -----------
PLR-124417-14 2

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

This responds to a letter dated June 5, 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, under the laws of State and made a valid S election effective
Date 2. The shareholders of X, in Year 1, formed two revocable inter vivos trusts, Trust
A and Trust B, and transferred their shares in X to the trusts.

On Date 3 a number of shares of X were transferred from Trust A and Trust B to Y, an
ineligible shareholder, thus causing a termination of X’s S election. After the discovery
of the terminating event, X and its shareholders took corrective action by having Y
transfer all its X shares back to Trust A and Trust B.

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 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 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 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 part that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d), (2) the Secretary determines that the
PLR-124417-14 3

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 shall be 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 3 because X had an ineligible
shareholder. However, we conclude that the termination was inadvertent within the
meaning of § 1362(f). Therefore, X will be treated as an S corporation effective Date 3
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