Corporation receives relief for invalid S and Qsub elections

Plain-English summary

A company attempted to elect S corporation status but did not obtain every required shareholder consent. A later amendment to its operating agreement also created a second class of stock, and the company corrected that problem by amending the agreement again. Because the S election was ineffective, the company's election to treat a newly acquired subsidiary as a qualified subchapter S subsidiary was also ineffective. The company and its shareholders had filed consistently with S corporation and Qsub treatment, and the company represented that the errors were inadvertent and not tax-motivated. The IRS granted inadvertent-invalid-election relief, treating the company as an S corporation from its intended effective date and the subsidiary as a Qsub from the corrective amendment date, subject to continued eligibility.

Ruling snapshot

• Question: May the company obtain relief for S and Qsub elections invalidated by missing shareholder consents and a second class of stock?
• Outcome: approved
• Key authorities: IRC §§ 1361(b) and 1362(d) and (f)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201801004                                              Third Party Communication: None
Release Date: 1/5/2018                                         Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.01-01
                                                               Person To Contact:
----------------------------------                             -------------------------------
-------------------------------------------                    ID No. ----------------
 ----------------------------------------------                Telephone Number:
 --------------------------------------------                  ----------------------
                                                               Refer Reply To:
                                                               CC:PSI:B01
                                                               PLR-113445-17
                                                               Date:
                                                               October 10, 2017

LEGEND

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

Sub              =        ------------------------
-------------------------------------------------------

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

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

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

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

Date 4            =        --------------------

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

        This responds to a letter dated April 18, 2017, and supplemental
correspondence, submitted on behalf of X, by X’s authorized representative, requesting
relief under section 1362(f) of the Internal Revenue Code (the Code).

Facts

       According to the information submitted and representations made within, X was
formed and made an S election effective Date 1, under the laws of State. Sub was
formed under the laws of State on Date 2. On Date 3, X acquired all of the outstanding
equity interests of Sub from the prior owner of those interests.

PLR-113445-17                                2

       X’s S corporation election was ineffective because X failed to obtain all required
shareholder consents to the election. Additionally, X represents an amendment to its
operating agreement on Date 4 created a second class of stock. X represents that it
has amended its operating agreement to correct all second class of stock issues.

      X elected to treat Sub as a Qualified Subchapter S Subsidiary (Qsub) effective
Date 3. Because X’s S corporation election was ineffective, X’s election to treat Sub as
a Qsub was also ineffective.

        X represents that the invalidity of its S election was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. X represents that all of X’s
distributions to shareholders have been pro rata in accordance with their ownership
interests. X also represents that X and its shareholders agree to make any adjustments
required as a condition of obtaining relief under the inadvertent invalid election rule as
provided under § 1362(f) that may be required by the Secretary. X and its shareholders
represent that they have filed all returns consistently with X being an S corporation and
Sub being a Qsub.

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 the 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 1 class of stock.

       Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be
terminated whenever (at any time on or after the 1st day of the taxable year for which
the corporation is an S corporation) such corporation ceases to be a small business
corporation.

       Section 1362(f) provides that if (1) an election under subsection (a) or section
1361(b)(3)(B)(ii) by any corporation (A) was not effective for the taxable year for which
made (determined without regard to subsection (b)(2)) by reason of a failure to meet the
requirements of section 1361(b) or to obtain shareholder consents, or (B) was
terminated under paragraph (2) or (3) of subsection (d) or section 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 (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 required shareholder consents;
and (4) the corporation for which the election was made or the termination occurred,

PLR-113445-17                                 3

and each person who was a shareholder in such corporation at any time during the
period specified pursuant to this subsection, agrees to make such adjustments
(consistent with the treatment of such 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 such
ineffectiveness or termination, such corporation shall be treated as an S corporation or
a qualified subchapter S subsidiary, as the case may be during the period specified by
the Secretary.

Conclusion

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election and X’s election to treat Sub as a Qsub were ineffective
on Date 1 and Date 3, respectively. We further conclude that the ineffectiveness of X’s
S corporation election and Sub’s Qsub election constituted inadvertent invalid elections
within the meaning of 1362(f). Therefore, X will be treated as an S corporation effective
Date 1 and thereafter, provided X’s S corporation election is otherwise valid and is not
otherwise terminated under § 1362(d). Furthermore, Sub will be treated as a Qsub of X
from Date 4 and thereafter, provided that Sub’s Qsub election was otherwise valid and
not otherwise terminated under 1361(b)(3)(C).

       Except as specifically ruled above, we express or imply no opinion as to the
federal income tax consequences of the facts described above under any other
provision of the code, including whether X was otherwise a valid S corporation and
whether Sub was otherwise a valid Qsub.

      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 the power of attorney on file with this office, we are sending a copy of
this letter to your authorized representative.

                                          Sincerely,

                                          Laura C. Fields

                                          Laura C. Fields
                                          Senior Technician Reviewer, Branch 1
                                          Office of Associate Chief Counsel
                                          (Passthroughs & Special Industries)
Enclosures (2)
      Copy of this letter
      Copy of this letter for section 6110 purposes

cc: