Partnership ownership did not permanently end S status

Plain-English summary

An S corporation shareholder transferred stock to a limited liability company taxed as a partnership, which was not an eligible S corporation shareholder. The error was discovered by new accountants, and the partnership later distributed the stock to two trusts represented to be electing small business trusts. The IRS found the termination inadvertent and treated the corporation as continuously maintaining S status. During the termination period, the two trusts would be treated as holding their respective shares directly and would account for the corporation's tax items, basis adjustments, and distributions under the normal S corporation rules.

Ruling snapshot

• Question: Could the corporation preserve S status after its stock was temporarily held by an ineligible partnership?
• Outcome: Approved, with the eligible trusts treated as direct owners during the termination period
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201525009 Third Party Communication: None
Release Date: 6/19/2015 Date of Communication: Not Applicable
Index Number: 1361.01-02, 1362.04-00
Person To Contact:
------------------------------------------------ -----------------------------, ID No. -------------
----------------------------- -----------------
------------------- Telephone Number:
------------------------------------ ----------------------
Refer Reply To:
CC:PSI:01
PLR-146615-14
Date:
March 09, 2015

Legend
X = ------------------------------------------------------------------------------------------------
----------------------------
State = --------------
Date 1 = ------------------------
Date 2 = --------------------
Date 3 = ------------------
Date 4 = ---------------------------
A = ------------------------------------------------------------------------------------------------
------------------------
P = ------------------------------------------------------------------------------------------------
-------------------------------
Trust 1 = ------------------------------------------------------------------------------------------------
-------------------------------
Trust 2 = ------------------------------------------------------------------------------------------------
-----------------------------

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

   This responds to a letter dated December 8, 2014, and subsequent

correspondence, submitted on behalf of X by its authorized representatives, requesting
a ruling relating to X’s status as an S corporation under §§ 1361 and 1362 of the
Internal Revenue Code.

                                                 FACTS

  The information submitted states that X was incorporated under the laws of State

on Date 1 and elected to be an S corporation effective Date 1. On Date 2, A, a
shareholder, transferred shares of X were transferred to P, a State limited liability
company taxable as a partnership for federal income tax purposes. Therefore, X's
PLR-146615-14 2

election terminated on Date 2. Trust 1 and Trust 2 have at all times been partners in P.
A was not aware that P was an ineligible shareholder of an S corporation and that the
transfer would terminate X's S corporation election. On Date 3, X engaged new
accountants to prepare its tax returns, who discovered shares of X had been transferred
to P and that this transfer terminated X's S corporation election.

  On Date 4, P distributed all of its shares of X stock to Trust 1 and Trust 2. X

represents that Trust 1 and Trust 2 are Electing Small Business Trusts (ESBTs) under
§ 1361(e)(3) as of Date 4.

   X represents that the termination of its S corporation election was inadvertent

and not motivated by tax avoidance or retroactive tax planning. Further, since Date 2, X
and X's shareholders have continually treated X as an S corporation. As such, all items
of income, gain, loss, and deduction recognized by X since Date 2 have been allocated
among the shareholders of X, including P. X and its shareholders have agreed to make
such adjustments as the Service may require with respect to all periods since Date 2.

                             LAW AND ANALYSIS

  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
PLR-146615-14 3

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 was terminated on Date 2 when shares of X
were transferred to P, an ineligible shareholder. We conclude, however, that this
termination was inadvertent within the meaning of § 1362(f). Accordingly, pursuant to
the provisions of § 1362(f), X will be treated as an S corporation effective Date 2 and
thereafter.

    During the termination period, Trust 1 and Trust 2 will be treated as if they held

their respective shares in X directly. Accordingly, in determining their respective income
tax liabilities during the termination period and thereafter, X's shareholders must include
their pro rata share of the separately and nonseparately computed items of X as
provided in § 1366, make any adjustments to basis as provided in § 1367, and take into
account any distributions made by X as provided in § 1368.

   Except as specifically set forth above, no opinion is expressed concerning the

federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed on whether X was or is otherwise eligible to
be treated as an S corporation.

  This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of

the Code 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 forwarded to X's authorized representatives.

                                    Sincerely,

PLR-146615-14 4

                      Laura C. Fields
                      Laura C. Fields
                      Senior Technician Reviewer, Branch 1
                      (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for 6110 purposes