Corporation receives late S election and inadvertent termination relief

Plain-English summary

A corporation intended to elect S status but did not know whether the service center received its Form 2553. Later, an unrelated S corporation acquired some of its shares, which would have terminated a valid S election because the buyer was not an eligible shareholder. The remaining shareholder trusts later transferred their stock to the buyer, which planned to elect qualified subchapter S subsidiary treatment for the target. The IRS found reasonable cause for the missing election and gave the corporation 120 days to file Form 2553 effective on the originally intended date. It also treated the later termination as inadvertent and allowed continuous S corporation treatment through the date the buyer became the sole shareholder, assuming the election was otherwise valid.

Ruling snapshot

• Question: Could the corporation obtain a late S election and preserve S status during ownership by an ineligible corporate shareholder?
• Outcome: approved, with 120 days to file Form 2553 and inadvertent termination relief through the corrective transfer
• Key authorities: IRC §§ 1361(b)(3), 1362(b)(5), and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201714014 Third Party Communication: None
Release Date: 4/7/2017 Date of Communication: Not Applicable
Index Numbers: 1362.01-03, 1362.04-00
Person To Contact:
------------------------- ----------------------, ID No. ----------------
------------------------------------------------------ Telephone Number:
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--------------------------- Refer Reply To:
CC:PSI:B03
PLR-121375-16
Date: January 3, 2017

                                                 LEGEND

X = -------------------------
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State = ------------

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

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

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

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

D4 = --------------

D5 = ---------------------

PLR-121375-16 2

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

  This letter responds to a letter dated June 27, 2016, and subsequent

correspondence submitted on behalf of X requesting rulings under §§ 1362(b)(5) and
1362(f) of the Internal Revenue Code (Code).

                                     FACTS

   The information submitted states that X was formed on D1 under the laws of

State. X’s initial shareholders are trusts that X represents are eligible S corporation
shareholders. X represents that it filed Form 2553, Election by a Small Business
Corporation, to be treated as an S corporation effective D2. However, X received no
acceptance notice from the service center and does not know whether the service
center received the election.

    On D3, an unrelated S corporation, Y, acquired shares of stock in X. Because Y

is an ineligible S corporation shareholder, X’s S corporation election, had it been
effective, would have terminated on D3. In D4, X learned that Y is an ineligible S
corporation shareholder and that as of D3 it no longer qualified as an S corporation. On
D5, the trusts transferred their X stock to Y in exchange for Y stock. Y plans to elect
under § 1361(b)(3) to treat wholly owned X as a qualified subchapter S subsidiary
(QSub) effective D5.

   X 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
Commissioner.

                              LAW AND ANALYSIS

  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(b)(1) provides that an election under § 1362(a) may be made by a

small business corporation for any taxable year (A) at any time during the preceding
taxable year, or (B) at any time during the taxable year and on or before the 15th day of
the third month of the taxable year.

   Section 1362(b)(3) provides that if (A) a small business corporation makes an

election under § 1362(a) for any taxable year, and (B) the election is made after the 15th
day of the third month of the taxable year and on or before the 15th day of the third

PLR-121375-16 3

month of the following taxable year, then such election shall be treated as made for the
following taxable year.

   Section 1362(b)(5) provides that if (A) an election under § 1362(a) is made for

any taxable year (determined without regard to § 1362(b)(3)), after the date prescribed
by § 1362(b) for making such election for such taxable year or no § 1362(a) election is
made for any taxable year, and (B) the Secretary determines that there was reasonable
cause for the failure to timely make the election, the Secretary may treat such an
election as timely made for the taxable year (and § 1362(b)(3) shall not apply).

    Section 1362(f) provides, in 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 (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 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 representations made, we conclude that

X has established reasonable cause for failing to make a timely election to be an S
corporation effective D2. Thus, we conclude that X is eligible for relief under
§ 1362(b)(5). Accordingly, if X makes an election to be an S corporation by filing a
completed Form 2553 with the appropriate service center effective D2, within 120 days
from the date of this letter, then such election will be treated as timely made. A copy of
this letter should be attached to the Form 2553.

   X failed to timely file an election to be treated as an S corporation effective D2.

Had X timely filed the election, it would have terminated on D3 when shares of X stock
were transferred to Y, an ineligible S corporation shareholder. Based solely on the facts
submitted and representations made, we conclude that X’s S corporation election
terminated on D3 when shares of X stock were transferred to Y. However, we conclude
that the circumstances surrounding the termination were inadvertent within the meaning
of § 1362(f). Pursuant to the provisions of § 1362(f), X will be treated as continuing to

PLR-121375-16 4

be an S corporation from D3 to D5, provided that X’s S corporation election is otherwise
valid and was not otherwise terminated under § 1362(d).

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

the federal tax consequences of the transactions described above under any other
provisions of the Code. Specifically, we express or imply no opinion regarding whether
X is otherwise eligible to be treated as an S corporation.

  The rulings are directed only to the taxpayer that requested it. Section

6110(k)(3) of the Code provides that the rulings may not be used or cited as precedent.

    Pursuant to a power of attorney on file with this office, we are sending a copy of

this letter to X’s authorized representative.

  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 ruling requests, it is subject to verification on
examination.

                                  Sincerely,

                                  /s/

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

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