Corporation receives inadvertent S election termination relief

Plain-English summary

An individual transferred some S corporation stock to another S corporation, an ineligible shareholder, which terminated the target corporation's S election. The parties did not know the transfer would cause a termination and continued filing returns consistent with S corporation status. After a later transfer left the shareholder corporation owning all the stock, it became eligible to make a QSub election for the target. The IRS treated the termination as inadvertent and allowed the target to remain an S corporation during the affected period, provided its original election was valid and no other termination occurred.

Ruling snapshot

• Question: Could the corporation continue to be treated as an S corporation after stock was transferred to an ineligible corporate shareholder?
• Outcome: Approved
• Key authorities: IRC §§ 1361(a), 1361(b)(1)(B), 1361(b)(3)(B), 1362(d)(2), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201550001 Third Party Communication: None
Release Date: 12/11/2015 Date of Communication: Not Applicable
Index Numbers: 1362.00-00, 1362.04-00
Person To Contact:
-------------------------------------- ------------------------, ID No. ----------------
----------------------------------------------- Telephone Number:
----------------------------- --------------------
-------------------------------- Refer Reply To:
CC:PSI:B3
PLR-102118-15
Date:
July 21, 2015

LEGEND

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

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

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

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

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

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

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

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

Year = ------

n = ---

p = ---

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

This letter responds to a letter dated December 16, 2014 and subsequent
correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under § 1362(f) of the Internal Revenue Code (“Code”).
PLR-102118-15 2

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 Year. On Date 2, A, an individual
and sole owner of X stock, transferred n% of the shares of X stock to B, an individual,
and p% of X stock to Y, an S corporation. Y was an ineligible S corporation shareholder
under § 1361(b)(1)(B). Accordingly, X’s S corporation election was terminated on Date

2. X and its shareholders were not aware that the transfer of X stock to Y would
   terminate X’s S corporation election. On Date 3, B transferred all of his stock to Y. As
   100% owner of X, Y could make a QSub election under § 1361(b)(3)(B).

X represents that X and its shareholders have filed tax returns consistent with X being
an S corporation from Date 2 to Date 3. 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 its shareholders have
agreed to make adjustments consistent with the treatment of X as an S corporation as
may be required by the Secretary.

LAW

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, in part, 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
PLR-102118-15 3

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.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the termination of X’s S corporation election on Date 2 was inadvertent within the
meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will
be treated as continuing to be an S corporation from Date 2 to Date 3, provided that X’s
S corporation election was valid and provided that the election was not otherwise
terminated under § 1362(d).

Except as specifically set forth above, we express or imply no opinion concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation or the validity of its S corporation election.

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



                                  Richard Probst
                                  Senior Technician Reviewer, Branch 3
                                  Office of Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: