S corporation receives relief for a missing consent and ineligible shareholder

Plain-English summary

A corporation's S election was initially ineffective because one shareholder did not properly consent. The corporation later contracted to sell shares to an ineligible entity, though the agreement was amended to substitute an eligible trust as purchaser from the original date. The IRS found both defects inadvertent under IRC § 1362(f) and allowed the corporation to be treated as an S corporation continuously from the intended effective date. Relief required the shareholder to file a proper consent statement within 120 days.

Ruling snapshot

• Question: Were the missing shareholder consent and temporary ineligible shareholder inadvertent S-election defects?
• Outcome: Approved, subject to filing the shareholder consent within 120 days
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1362-6

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201634003 Third Party Communication: None
Release Date: 8/19/2016 Date of Communication: Not Applicable
Index Numbers:1362.00-00, 1362.01-00,
1362.01-01, 1362.04-00 Person To Contact:
----------------------, ID No. -----------------
-------------------------------------------- Telephone Number:
------------------------------------------ -------------------
--------------------------------- Refer Reply To:
-------------------------------- CC:PSI:B3
PLR-103268-16
Date:
March 21, 2016

                                                Legend

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

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

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

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

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

Trust = -----------------------

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

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

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

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

Date 4 = -------------------
PLR-103268-16 2

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

    This letter responds to a letter dated January 21, 2016, submitted on behalf of X

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

                                      Facts

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

on Date 1. X elected to be an S corporation effective Date 2. On Date 2, the
shareholders of X were A and B. However, B failed to consent properly to X’s S
corporation election. Accordingly, X’s S corporation election was ineffective.

   In addition, on Date 3, X entered into a Common Share Purchase Agreement for

the sale of common stock of X to Y, an ineligible shareholder under § 1361(b)(1). The
sole member of Y is Trust, an eligible shareholder pursuant to § 1361(c)(2)(A)(i). The
grantor and trustee of Trust is C. On Date 4, X, Y, and C, as trustee for Trust, entered
into a First Amendment to Common Shares Purchase Agreement which provided that
Trust was substituted for Y as the purchaser of X shares, effective Date 3.

    X represents that there was no tax avoidance or retroactive tax planning involved

in the failure of B to properly execute X’s Form 2553 and in the transfer of shares of X to
Y. In addition, 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. X also
represents that X and all its shareholders have filed consistently with X being treated as
an S corporation. In addition, X represents that all items allocable to the shares
originally purchased by Y were allocated to and reported by Trust, an eligible
shareholder.

                                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)(B) provides that the term “small business corporation” means

a domestic corporation that is not an ineligible corporation and that does not, among
other requirements, 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.
PLR-103268-16 3

   Section 1361(c)(2)(A)(i) provides that, for purposes of § 1361(b)(1)(B), a trust all

of which is treated (under subpart E of part I of subchapter J of chapter 1 of the Code)
as owned by an individual who is a citizen or resident of the United States may be a
shareholder.

  Section 1362(a)(1) 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) is 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 that if (1) an election under § 1362(a) or

§ 1361(b)(3)(B)(ii) by any corporation (i) 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 (ii) was terminated
under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (2) the Secretary determines that the
circumstances resulting in such ineffectiveness or termination were inadvertent; (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
such 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 or a
QSub, as the case may be, or to acquire the required 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), agree to make the adjustments (consistent with the treatment of
the corporation as an S corporation or a QSub, as the case may be) as may be required
by the Secretary with respect to this period, then, notwithstanding the circumstances
resulting in such ineffectiveness or termination, the corporation shall be treated as an S
corporation or a QSub, as the case may be, 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 on Date 2 as a result of the improper consent
to X’s S corporation election. We further conclude that the ineffectiveness of X’s S
corporation election constituted an inadvertent invalid election within the meaning of
§ 1362(f). In addition, because X had an ineligible S corporation shareholder on Date 3,
we conclude that X’s S corporation election would have terminated on Date 3 had X’s S
corporation election been effective on Date 2. We further conclude that the termination
of X’s S corporation election on Date 3 was inadvertent within the meaning of § 1362(f).
PLR-103268-16 4

Consequently, under § 1362(f), X will be treated as an S corporation from Date 2 and
thereafter provided that X’s S corporation election was otherwise valid and not
otherwise terminated under § 1362(d).

   As a condition of the rulings, B must sign a written statement as described in

§ 1.1362-6(b)(1) consenting to X’s S corporation election effective Date 2. The written
statement must be filed with the appropriate service center within 120 days from the
date of this letter, indicating that the statement is to be associated with X’s originally
filed Form 2553.

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the facts described above under any other provision of
the Code, including whether X was otherwise a valid 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 for precedent.

   Pursuant to a power of attorney on file, we are sending a copy of this letter to X’s

authorized representatives.

  The rulings contained in this letter are 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 rulings requested, it is subject to verification on
examination.

                                  Sincerely,



                                  Bradford R. Poston
                                  Senior Counsel, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: