Partnership shareholder caused inadvertent S termination

Plain-English summary

Two shareholders of an S corporation transferred their stock to a partnership, which was not an eligible S corporation shareholder. The corporation’s S election therefore terminated on the transfer date. After discovering the error, the partnership promptly transferred the shares to eligible shareholders, and the corporation and its owners continued to report consistently with S status and agreed to any required adjustments. The IRS found the termination inadvertent under section 1362(f) and treated the corporation as an S corporation through its later restructuring, assuming the election was otherwise valid.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after stock was transferred to an ineligible partnership shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1361(b)(1)(B), 1362(d)(2), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201524009 Third Party Communication: None
Release Date: 6/12/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------------------- ---------------------, ID No. ------------
----------------------- Telephone Number:
--------------------------------------- --------------------
--------------------------- Refer Reply To:
CC:PSI:B01
PLR-133842-14
Date:
March 04, 2015

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

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

State = --------

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

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

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

Date 4 = -------------------------
------------------------------------------------------------------------------------------------------
Date 5 = --------------------

Dear --------------

This letter responds to a letter dated September 9, 2014, submitted on behalf of X,
requesting relief under § 1362(f) of the Internal Revenue Code.

Facts

The information submitted states that X was formed under the laws of State on Date 1
and elected to be treated as an S corporation effective Date 2. Prior to Date 3, eligible
S corporation shareholders owned all of the stock of X. On Date 3, however, two of X’s
shareholders contributed their stock in X to A, a partnership, which is an ineligible S
corporation shareholder under § 1361(b)(1)(B). X represents that upon discovery of its

PLR-133842-14 2

error, it promptly took remedial action. On Date 4, A executed a document transferring
all of its X shares to eligible S corporation shareholders.

X represents that the transfer of X stock to A, an ineligible shareholder, was not
motivated by avoidance or retrospective tax planning. X and its shareholders have
continued to treat X as an S corporation at all times. X and its shareholders agree to
make any adjustments (consistent with the treatment of X as an S corporation) that the
Secretary may require.

Law

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which
an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a “small business corporation” means a domestic
corporation that is not an ineligible corporation and that 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 first day of the first taxable year for which a
corporation is an S corporation) such corporation ceases to be a small business
corporation. A termination of an S corporation election under § 1362(d)(2) is effective
on and after the date of cessation.

Section 1362(f) provides 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 such termination were inadvertent, (3) no later than a
reasonable period of time after discovery of the event resulting in the ineffectiveness,
steps were taken (A) so that the corporation is a small business corporation, or (B) to
acquire the required shareholder consents, 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 such
ineffectiveness, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

Conclusion

Based solely on the information submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 3, when X stock was transferred to A,
an ineligible shareholder. We also conclude that this termination was inadvertent within
the meaning of § 1362(f), and that under the provisions of § 1362(f), X will be treated as

PLR-133842-14 3

an S corporation from Date 3 until Date 5, when X was restructured, provided that X’s S
election was valid and was not otherwise terminated.

Except for the specific ruling above, we express no opinion concerning the federal tax
consequences of the facts described above under any other provision of the Code.
Specifically, no opinion is expressed concerning whether X was otherwise eligible to be
treated as 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 a power of attorney on file with this office, a copy of this letter is being sent
to X’s authorized representatives.

                                    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 for § 6110 purposes

cc: