Corporation receives relief for an invalid S election

Plain-English summary

A corporation intended to begin S corporation treatment after an ineligible shareholder transferred its interest to an eligible shareholder. The parties intended the transfer to occur before the election became effective, but it was not finalized until later. The corporation timely filed Form 2553 because its tax department believed the ownership transfer was complete, then took corrective action after discovering the error. The IRS found that the election's invalidity was inadvertent and not motivated by tax avoidance or retroactive tax planning. It treated the corporation as an S corporation from the intended effective date, provided the election was otherwise valid and did not otherwise terminate.

Ruling snapshot

• Question: Could the corporation preserve S status after an ineligible shareholder remained in place when the election became effective?
• Outcome: Approved.
• Key authorities: IRC §§ 1361 and 1362(d) and (f).

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 201636017                                               Third Party Communication: None
Release Date: 9/2/2016                                          Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                                Person To Contact:
------------------------------------------                      -------------------, ID No. ----------------
-----------------------                                         Telephone Number:
--------------------------------------                          --------------------
 -------------------------------------------                    Refer Reply To:
                                                                CC:PSI:B01
                                                                PLR-115451-16
                                                                Date:
                                                                May 27, 2016




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

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

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

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

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

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

Date 3                     =       --------------------
                                   ---------------------------------------------------------------------------------------------------
Date 4                     =       ---------------------------------------------------------------------------------------------------
                                   ---------------------------------------------------------------------------------------------------
Year C                     =       ---------------------------------------------------------------------



Dear -----------------

This letter responds to a letter dated May 9, 2016, submitted on behalf of X, requesting
relief under § 1362(f) of the Internal Revenue Code.

Facts

The information submitted states that X was formed under the laws of State on Date 1
and elected to be treated as an S corporation effective Date 2. Prior to the election, X
PLR-115451-16                                2

determined that one of its shareholders, A, was not an eligible S corporation
shareholder. A took steps to distribute its interest to B, an eligible shareholder. The
parties intended the transfer to be effective prior to Date 2 but the transactions were not
finalized until Date 3. On Date 4, Form 2553 was timely filed due to the tax department
assuming ownership transfer was perfected. In early Year C, X discovered the error
and promptly took remedial action.

X represents that the circumstances resulting in the ineffectiveness of X’s S corporation
election were inadvertent and not motivated by tax avoidance or retroactive tax
planning. X and its shareholders have continued to treat X as an S corporation at all
times. X and its shareholders agree to make any adjustments (consistent with the
treatment of X as an S corporation) that the Secretary may require.

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 any
corporation was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that
the circumstances resulting in such termination were inadvertent, (3) no later than a
reasonable period of time after discovery of the event resulting in the ineffectiveness,
steps were taken (A) so that the corporation is a small business corporation, or (B) to
acquire the required 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 such
ineffectiveness, the corporation shall be treated as an S corporation during the period
specified by the Secretary.
PLR-115451-16                                  3


Conclusion

Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election was invalid on Date 2 because it had an ineligible
shareholder, A. We also conclude that this termination was inadvertent within the
meaning of § 1362(f). Therefore, X will be treated as an S corporation effective Date 2
and thereafter, provided that X’s S corporation election was otherwise valid and not
otherwise terminated under § 1362(d).

Except for the specific ruling above, we express no opinion concerning the federal tax
consequences of the facts described above under any other provision of the Code.
Specifically, no opinion is expressed concerning whether X was otherwise eligible to be
treated as an S corporation.

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

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent
to X’s authorized representatives.


                                        Sincerely,


                                        David R. Haglund
                                        David R. Haglund
                                        Branch Chief, Branch 1
                                        Office of the Associate Chief Counsel
                                        (Passthroughs & Special Industries)

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


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