Inadvertent S corporation termination and invalid successor election receive relief

Plain-English summary

An S corporation predecessor temporarily had an ineligible shareholder, terminating its S election. A successor corporation then attempted to elect S status before the predecessor was eligible to make a new election, making the successor's election invalid. The corporations represented that the failure was not motivated by tax avoidance or retroactive planning and that the successor and its shareholders consistently filed as though S status remained in effect. They also agreed to make any adjustments the IRS required. The IRS treated the termination as inadvertent under section 1362(f), preserved the predecessor's S status through the transition date, and treated the successor as an S corporation from its election date forward, assuming it was otherwise eligible.

Ruling snapshot

• Question: Could the predecessor's inadvertent S termination and the successor's resulting invalid S election be disregarded under section 1362(f)?
• Outcome: Approved, both corporations are treated as S corporations for the specified periods
• 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: 201530016 Third Party Communication: None
Release Date: 7/24/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------------------------------ -------------------------, ID No. ------------
------ Telephone Number:
------------------------------------ --------------------
------------------- Refer Reply To:
-------------------------------- CC:PSI:B03
PLR-143030-14
Date:
February 12, 2015

LEGEND

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

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

State1 = -------------

State2 = ------------

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

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

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

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

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

   This letter responds to a letter dated November 19, 2014, and subsequent

correspondence, submitted on behalf of X by its authorized representative requesting a
ruling under § 1362(f) of the Internal Revenue Code (Code).
PLR-143030-14 2

                                      FACTS

    The information submitted states that X is a successor corporation to Y, which

was organized under the laws of State1 on D1 and elected to be an S corporation
effective D2. X was organized under the laws of State2 on D3 and elected to be an S
corporation effective D4. Between D3 and D4, Y had an ineligible shareholder and its S
corporation election terminated. As a result, X’s election on D4 to be an S corporation
was invalid.

   X and Y represent that the termination was not motivated by tax avoidance or

retroactive tax planning. X further represents that X and its shareholders have filed
consistently with the treatment of X as an S corporation since D4. X and its
shareholders 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
PLR-143030-14 3

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.

   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.

   Section 1362(g) provides that, if a small business corporation has made an

election under § 1362(a) and if such election has been terminated under § 1362(d),
such corporation (and any successor corporation) shall not be eligible to make an
election under subsection (a) for any taxable year before its 5th taxable year which
begins after the 1st taxable year for which such termination is effective, unless the
Secretary consents to such election.

                                 CONCLUSION

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

that Y’s S corporation election terminated on D3, and therefore X’s S corporation
election on D4 was invalid. We also conclude that the circumstances resulting in the
termination were inadvertent within the meaning of § 1362(f). Accordingly, under
§ 1362(f), Y will be treated as an S corporation from D3 to D4, and X will be treated as
an S corporation from D4 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.
PLR-143030-14 4

  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.

  In accordance with a power of attorney on file with this office, we are sending

copies of this letter to X’s authorized representatives.

                                  Sincerely,



                                  Bradford R. Poston
                                  Senior Counsel, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs and Special Industries)

Enclosures (2):

  Copy of this letter
  Copy for § 6110 purposes

cc: