Subsidiary receives relief for an ineffective QSub election

Plain-English summary

An S corporation acquired all the stock of another S corporation in a transaction represented to be an IRC § 368(a)(1)(F) reorganization. The acquired corporation later converted to a limited liability company, and the parent attempted to elect qualified subchapter S subsidiary status effective before the subsidiary met all QSub requirements. The IRS concluded that the election was ineffective but that the failure was inadvertent under IRC § 1362(f), so the subsidiary would be treated as a QSub from the requested effective date. The ruling did not determine whether the reorganization qualified or whether the subsidiary was otherwise eligible for QSub status.

Ruling snapshot

• Question: Can an inadvertently ineffective QSub election be treated as effective from the requested date?
• Outcome: Approved. The subsidiary will be treated as a QSub from that date if the election was otherwise valid and not otherwise terminated.
• Key authorities: IRC §§ 1361(b)(3), 1362(f), 368(a)(1)(F); Treas. Reg. § 1.1361-3(a)(1)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201724013
Third Party Communication: None
Release Date: 6/16/2017
Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
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ID No. ----------------
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Telephone Number:
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Refer Reply To:
CC:PSI:B01
PLR-129573-16
Date:
March 08, 2017

LEGEND

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

Sub = --------------------------------------------
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State = ----------

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

D2 = -------

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

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

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

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

This letter responds to a letter dated September 21, 2016, and subsequent information, 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 under the laws of State on D1, and made an election to be a subchapter S corporation effective D1. Sub was

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organized under the laws of State in D2, and made an election to be a subchapter S corporation effective D3. On D4, incident to what X represents was part of a reorganization under § 368(a)(1)(F), Sub's shareholders contributed all of their stock in Sub to X, thereby causing Sub to become a wholly owned subsidiary of X. Sub then converted to a limited liability company under State law on D5, and by default was treated as a disregarded entity for federal tax purposes. Afterwards, X made an election to treat Sub as a qualified subchapter S subsidiary (“QSub”) effective on D4. However, X discovered that its election to treat Sub as a QSub was ineffective due to Sub' s failure to meet all the requirements of § 1361(b)(3)(B) at the time the election was made.

X represents that the ineffective QSub election for Sub was inadvertent and not the result of tax avoidance or retroactive tax planning. X further represents that no federal tax return of any person has been filed inconsistent with a valid QSub election having been made for Sub effective D4. Sub and X have agreed to make any adjustments required by the Service consistent with the treatment of Sub as a QSub.

LAW AND ANALYSIS

Section 1361(b)(3)(A) provides that, except as provided in regulations prescribed by the Secretary, for purposes of the Code-(i) a corporation which is a QSub shall not be treated as a separate corporation, and (ii) all assets, liabilities, and items of income, deduction, and credit of a QSub shall be treated as assets, liabilities, and such items (as the case may be) of the S corporation.

Section 1361(b)(3)(B) provides that the term “QSub” means any domestic corporation which is not an ineligible corporation (as defined in § 1361(b)(2)), if (i) 100 percent of the stock of such corporation is held by the S corporation, and (ii) the S corporation elects to treat such corporation as a QSub.

Section 1.1361-3(a)(1) of the Income Tax Regulations provides that the corporation for which a QSub election is made must meet all the requirements of § 1361(b)(3)(B) at the time the election is made and for all periods for which the election is to be effective.

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

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QSub, 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 QSub, 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 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 election to treat Sub as a QSub on D4 was ineffective. We also conclude that the circumstances resulting in the ineffectiveness of the QSub election were inadvertent within the meaning of § 1362(f). Thus, under the provisions of § 1362(f), Sub will be treated as a QSub effective on D4, provided that Sub's QSub election was otherwise valid and not otherwise terminated under § 1361(b)(3)(C).

Except as expressly provided herein, we express or imply no opinion concerning the federal tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express or imply no opinion on whether Sub was otherwise eligible to be treated as a QSub or on the validity of the reorganization under § 368(a)(1)(F) or its tax consequences.

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.

Sincerely,

Joy C.Spies
Joy C. Spies
Senior Technician Reviewer, Branch 1
Office of Associate Chief Counsel
(Passthroughs & Special Industries)

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