Partnership-style provisions did not defeat S status after correction

Plain-English summary

A limited liability company elected S corporation status while its operating agreement still contained partnership provisions that created different distribution or liquidation rights and therefore more than one class of stock. After discovering the problem, the members amended the agreement to give everyone identical rights. The company represented that the error was inadvertent, all actual distributions and income allocations had been pro rata, no return had been filed inconsistently with S corporation treatment, and the company and shareholders would make any required adjustments. The IRS agreed that the election was initially ineffective but treated the failure as inadvertent under section 1362(f). The company would therefore be treated as an S corporation from the intended effective date, assuming the election was otherwise valid and not later terminated.

Ruling snapshot

• Question: Could the company retain S corporation treatment after correcting operating-agreement terms that created a second class of stock?
• Outcome: Approved, the ineffective election received inadvertent-failure relief
• Key authorities: IRC §§ 1361(b)(1)(D) and 1362(f); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201624003                                              Third Party Communication: None
Release Date: 6/10/2016                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                               Person To Contact:
---------------------------------------                        -----------------------, ID No. -------------------
---------------------------------------                        ---------------------------------------------------
-----------------------------------                            Telephone Number:
------------------------------                                 ----------------------
                                                               Refer Reply To:
                                                               CC:PSI:B03
                                                               PLR-127913-15
                                                               Date: February 4, 2016




                                                      LEGEND

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

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

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

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


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

       This letter responds to a letter dated August 18, 2015, and subsequent
correspondence submitted on behalf of X requesting a ruling under § 1362(f) of the
Internal Revenue Code (Code).

                                                      FACTS

       According to the information submitted, X was organized as a limited liability
company under the laws of State on D1. Subsequently, X made an election to be
treated as an S corporation effective D2. At the time of its S corporation election, X’s
operating agreement included provisions relating to partnerships that caused X to have
more than one class of stock. When X’s members later discovered the effect of the
partnership provisions, they amended the operating agreement to remove the
provisions and provide identical distribution and liquidation rights to X’s members.

       X represents that the ineffective S corporation election was inadvertent and not
the result of tax avoidance or retroactive tax planning. X further represents that no
PLR-127913-15                                 2

federal tax return of any person has been filed inconsistent with a valid S corporation
election having been made for X effective D2. X also represents that all distributions
and allocations of income to its shareholders have been made pro rata in accordance
with their interests in X. X and its shareholders have agreed to make any adjustments
required by the Service consistent with the treatment of X as an S corporation.

                                   LAW AND ANALYSIS

        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 such year.

       Section 1361(b)(1) defines a "small business corporation" as 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(f) provides that if (1) an election under § 1362(a) or
§ 1361(b)(3)(B)(ii) 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) or § 1361(b)(3)(C), (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 for which
the election was made or the termination occurred is a small business corporation or a
qualified subchapter S subsidiary, as the case may be, or (B) to acquire the shareholder
consents, 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 or a qualified subchapter S
subsidiary, as the case may be) 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 or a qualified subchapter
S subsidiary, as the case may be, during the period specified by the Secretary.

      Section 1.1361-1(l)(1) of the Income Tax Regulations provides, in part, that a
corporation is generally treated as having only one class of stock if all outstanding
shares of stock of the corporation confer identical rights to distribution and liquidation
proceeds.
PLR-127913-15                                3

       Section 1.1361-1(l)(2)(i) provides that the determination of whether all
outstanding shares of stock confer identical rights to distribution and liquidation
proceeds is made based on the corporate charter, articles of incorporation, bylaws,
applicable state laws, and binding agreements relating to distribution and liquidation
proceeds (collectively, governing provisions).

                                      CONCLUSION

       Based solely on the facts submitted and representations made, we conclude that
X’s S corporation election was ineffective for having more than one class of stock. We
also conclude that the circumstances resulting in any ineffectiveness of X’s S
corporation election were inadvertent within the meaning of § 1362(f). Thus, under the
provisions of § 1362(f), X will be treated as an S corporation effective on D2, and
thereafter, provided that X’s S corporation election was otherwise valid and not
otherwise terminated under § 1362(d).

       Except as expressly provided herein, we express or imply no opinion concerning
the federal tax consequences of the facts of this case under any other provisions of the
Code. Specifically, we express or imply no opinion on whether X was otherwise eligible
to be an S corporation.

       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.

       Pursuant to a power of attorney on file, 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,

                                      /s/

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

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