Corporation receives relief for ineligible S corporation shareholder

Plain-English summary

A corporation elected S corporation status effective on its formation date, but one shareholder was not eligible to own S corporation stock. After discovering the problem, that shareholder promptly distributed its shares to its individual owners, all of whom were eligible shareholders. The corporation represented that the ineffective election was inadvertent and not motivated by tax avoidance or retroactive planning, and it and its shareholders agreed to make any required adjustments. The IRS granted relief under IRC § 1362(f) and treated the corporation as an S corporation from its original election date, provided the election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Question: Could a corporation retain S corporation treatment when its original election was ineffective because an ineligible entity held shares?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201548015 Third Party Communication: None
Release Date: 11/27/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------- -------------------------, ID No. -----------------
-------------------------------------------- ----------------------------------------------------
------------------ Telephone Number:
-------------------------- --------------------
Refer Reply To:
CC:PSI:B03
PLR-109876-15
Date:
August 11, 2015

Legend

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

State = -----------------

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

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

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

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

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

    This letter responds to a letter dated March 13, 2015, submitted on behalf of X by

its authorized representative, requesting a ruling under § 1362(f) of the Internal
Revenue Code (Code).

                                               FACTS

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

on D1 and elected to be an S corporation effective D1. On D2, X learned that A was not
an eligible S corporation shareholder and therefore X’s election to be an S corporation
was ineffective. Soon thereafter on D3, A distributed its shares in X to A’s individual
owners, all of whom are eligible S corporation shareholders.
PLR-109876-15 2

   X represents that the circumstances resulting in X’s ineffective S corporation

election were inadvertent and not motivated by tax avoidance or retroactive tax
planning. X and its shareholders agree to make any adjustments consistent with the
treatment of X as an S corporation as may be required by the Secretary.

                              LAW AND ANALYSIS

    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(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 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(d)(2)(B) provides that any termination under
§ 1362(d)(2)(A) is effective on and after the date of cessation.

    Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a)

by any 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 so that the corporation for which the election was made or
the termination occurred is a small business corporation, and (4) the corporation for
which the election was made or the termination occurred 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.
PLR-109876-15 3

                                 CONCLUSION

    Based solely on the information submitted and the representations made, we

conclude that X’s S corporation election was ineffective on D1 because A was an
ineligible S corporation shareholder. We further conclude that X’s ineffective S
corporation election was inadvertent within the meaning of § 1362(f). Accordingly,
pursuant to the provisions of § 1362(f), X will be treated as an S corporation from D1
and thereafter, provided that X’s S corporation election was otherwise valid and has not
otherwise terminated under § 1362(d).

   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.

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

copy of this letter to X’s authorized representative.

   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.

                                      Sincerely,



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

Enclosures (2):

   Copy of this letter
   Copy for § 6110 purposes

cc: