Partnership shareholder caused inadvertent S termination

Plain-English summary

Two shareholders transferred their S corporation stock to a limited partnership, an ineligible S corporation shareholder. After discovering the resulting termination, the partnership distributed the stock pro rata to its individual owners, with stock otherwise allocable to an LLC distributed directly to that LLC’s individual members. The IRS found the termination inadvertent and ruled that the corporation would continue to be treated as an S corporation from the transfer date, provided its election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Request: Treat the S corporation termination caused by a partnership shareholder as inadvertent
• Outcome: Approved; continuous S corporation treatment from the termination date
• Key authorities: I.R.C. §§ 1361(b)(1)(B), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(f)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201544006                                             Third Party Communication: None
Release Date: 10/30/2015                                      Date of Communication: Not Applicable
Index Numbers: 1361.01-02, 1362.04-00                         Person To Contact:
                                                              -------------------------, ID No. ------------------
---------------------------------------------------------     -----------------------------------------------------
---------------------------------------------                 Telephone Number:
---------------------                                         ----------------------
--------------------------------                              Refer Reply To:
                                                              CC:PSI:B03
                                                              PLR-103874-15
                                                              Date:
                                                              July 14, 2015



LEGEND

X = ---------------------------------------------------------------------------------------------------------------
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Y = -------------------------------------------------------------------------
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Z = ---------------------------------------------------------
-------------------------------

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

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

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

D = -------------------------

E = -----------------------

State = ---------

Date1 = ---------------------------

Date2 = ----------------------

Date3 = ---------------------------

Date4 = ---------------------------

Date5 = ---------------------------

PLR-103874-15                                 2


Date6 = ---------------------------

Date7 = -----------------------

Date8 = ----------------------------

N1 = --

N2 = ------

N3 = ----

N4 = ----



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

       This letter responds to a letter dated January 6, 2015, and subsequent
correspondence, submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code (Code).

       The information submitted states that X was formed under the laws of State on
Date1 and elected to be treated as an S corporation effective Date2. A and B formed Y,
a State limited liability company, on Date3, and Z, a State limited partnership, on Date4.
At the time of Z’s formation, Y owned an N1% general partnership interest in Z, and A
and B each owned an N2% limited partnership interest in Z. In addition, A and B each
own an N3% interest in Y. On Date5, A and B each transferred their respective shares
of X stock to Z. On Date6, A and B each transferred by gift an N4% limited partnership
interest in Z to each of C, D and E (the children of A and B).

        In Date7, X learned that Z was an ineligible shareholder and that X’s S
corporation election had terminated effective Date5. Shortly thereafter, on Date8, Z
distributed all of the stock of X to its individual owners, on a pro rata basis. To avoid
multiple transfers, any stock distributable to Y was instead distributed directly to A and
B, as the members of Y. X’s tax return for such tax year was prepared consistent with
this treatment.

        X represents that X and X’s shareholders have filed tax returns consistent with X
being an S corporation since Date2. X further represents that the circumstances
resulting in the termination of X’s S corporation election were inadvertent and were not
motivated by tax avoidance or retroactive tax planning. X and persons who were or are
shareholders of X at any time since Date5 agree to make any adjustments (consistent

PLR-103874-15                                 3

with the treatment of X as an S corporation) as may be required by the Secretary with
respect to such period.

        Section 1361(a) 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) provides that the term “small business corporation” means a
domestic corporation that is not an ineligible corporation and that meets the
requirements specified in § 1361(b)(1)(A) through (D).

       Section 1361(b)(1)(B) provides that S corporations may 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 1.1361-1(f) of
the Income Tax Regulations provides that, except as otherwise provided in § 1.1361-
1(e)(1) (relating to nominees), § 1.1361-1(h) (relating to certain trusts), and, for taxable
years beginning after December 31, 1997, §1361(c)(6) (relating to certain exempt
organizations), a corporation in which any shareholder is a corporation, partnership, or
trust does not qualify as a small business corporation.

        Section 1362(d)(2)(A) 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 the corporation is an S corporation) such corporation ceases to be a small
business corporation. Section 1362(d)(2)(B) provides that any termination shall be
effective on and after the date of cessation.

       Section 1362(f) provides that if (1) an election under § 1362(a) by a corporation
(A) 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 or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary
determines that the circumstances resulting in the ineffectiveness or termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in the ineffectiveness or termination, 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 or termination, the
corporation will be treated as an S corporation during the period specified by the
Secretary.

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date5 due to the transfer of X stock to Z,

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an ineligible shareholder. We further conclude that this termination was inadvertent
within the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), X will be
treated as continuing to be an S corporation from Date5, and thereafter, provided that
X’s S corporation election was valid and the election was not otherwise terminated
under § 1362(d).

       Except as specifically set forth above, we express or imply no opinion concerning
the federal income tax consequences of the facts described above under any other
provision of the Code and the regulations thereunder. Specifically, we express or imply
no opinion regarding whether X otherwise qualifies as a small business corporation
under § 1361.

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

       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.

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

                                      Sincerely,



                                      Mary Beth Carchia
                                      Senior Technician Reviewer, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)


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

cc: