Missing spousal consents made S election inadvertently ineffective

Plain-English summary

Three shareholders signed an S corporation election, but their spouses did not sign even though community-property rules required their consent. The corporation and its shareholders consistently filed as though the election were effective, and a successor corporation later sought relief after a tax-free reorganization. The IRS found the ineffective election inadvertent and treated the original corporation as an S corporation from the intended effective date. Relief was conditioned on filing the missing spousal consents with the appropriate service center within 120 days. The IRS did not decide whether the original or successor corporation otherwise qualified for S status.

Ruling snapshot

• Question: Could the original corporation’s S election be treated as effective despite missing community-property spousal consents?
• Outcome: Approved, conditioned on filing the consents within 120 days
• Key authorities: IRC §§ 1362(a)(2) and 1362(f); Treas. Reg. § 1.1362-6(b)(2)(i)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201531008 Third Party Communication: None
Release Date: 7/31/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
---------------------------- ------------------------, ID No. ------------------
------------------------------------------- ----------------------------------------------------
----------------- Telephone Number:
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Refer Reply To:
CC:PSI:B3
PLR-130275-14
Date: January 30, 2015

LEGEND

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

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

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

B = ----------------------

C = ----------------------

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

State 2 = -------------

State 3 = -------------

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

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

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

Dear ---------------:
PLR-130275-14 2

This letter responds to a letter dated August 8, 2014, and subsequent
correspondence, submitted on behalf of Y, requesting a ruling under § 1362(f) of the
Internal Revenue Code (Code).

FACTS

The information submitted states that X was incorporated in State 1 on Date 1
and elected to be treated as an S corporation effective Date 1. A, B and C, the three
original shareholders, signed the Form 2553, Election by a Small Business Corporation.
Although all of the original shareholders were subject to the community property laws of
State 2, their spouses did not sign the Form 2553 as required by § 1.1362-6(b)(2)(i) of
the Income Tax Regulations. As a result, X’s S corporation election was ineffective.

Y represents that it is the successor to X’s S corporation election following a tax-
free reorganization under § 368(a)(1)(F) on Date 3. Y was incorporated in State 3 on
Date 2.

As X’s successor, Y represents that the spouses’ failure to consent to the S
corporation election and the resulting ineffective S corporation election was inadvertent
and not motivated by tax avoidance or retroactive tax planning. The shareholders
believed all required consents necessary to make X’s S corporation election effective
had been obtained. Y also represents that, since its formation, X consistently reported
its federal taxable income on Form 1120S, U.S. Income Tax Return for an S
Corporation, issued Schedule K-1s annually to its shareholders and, to the best of its
knowledge, the shareholders of X reported the income set forth on their annual
Schedule K-1s consistent with X being an S corporation. Y and its shareholders have
agreed to make any adjustments consistent with the treatment of X as an S corporation
as may be required by the Commissioner with respect to the period specified by
§ 1362(f).

LAW

Section 1362(a)(2) provides that an S corporation election shall be valid only if all
persons who are shareholders in such corporation on the day on which such election is
made consent to such election.

Section 1.1362-6(a)(2)(i) provides that an S election is not valid unless all
shareholders of the corporation at the time of the election consent to the election in the
manner provided in 1.1362-6(b).

Section 1.1362-6(b)(2)(i) provides that when the stock of a corporation is owned
by husband and wife as community property (or the income from the stock is community
property), each person having a community interest in the stock or income therefrom
PLR-130275-14 3

must consent to the election.

Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
corporation was not effective for the taxable year for which made (determined without
regard to § 1362(b)(2)) by reason of a failure to meet the requirements of § 1361(b) or
to obtain shareholder consents, (2) the Secretary determines that the circumstances
resulting in the ineffectiveness were inadvertent, (3) no later than a reasonable period of
time after discovery of the circumstances resulting in the ineffectiveness, steps were
taken (A) so that the corporation is a small business corporation or (B) to acquire the
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 the ineffectiveness, the corporation will
be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that
X's S corporation election was ineffective because it was not signed by the spouses of
shareholders subject to community property laws. We also conclude that the
ineffectiveness of X’s S corporation election was inadvertent within the meaning of
§ 1362(f). Accordingly, under § 1362(f), X will be treated as having been an S
corporation from Date 1, provided that X's S corporation election was not otherwise
invalid and not otherwise terminated under § 1362(d).

This ruling is contingent on filing copies of the consents to the S corporation
election that were submitted with this ruling request with the appropriate service center,
indicating that these consents are to be associated with the originally filed Form 2553,
within 120 days of this letter. A copy of this letter should be attached to the filing.

Except as specifically ruled above, we express or imply no opinion concerning
the federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, we express or imply no opinion as to whether X or
Y was or is, respectively, otherwise eligible to be treated as an S corporation.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
of the Code provides that it may not be used or cited as precedent.
PLR-130275-14 4

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

Sincerely,

Holly Porter
Branch Chief, Branch 3
Office of Associate Chief Counsel
(Passthroughs & Special Industries)

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