S corporation receives relief for stock held by two partnerships

Plain-English summary

All shares of an S corporation were transferred first to one partnership and then to another. Because a partnership is not an eligible S corporation shareholder, the first transfer terminated the corporation's S election. After discovering the problem, the parties transferred the shares from the second partnership to an eligible shareholder and allocated later income and other items to that shareholder. The corporation represented that the termination was unintended, was not motivated by tax avoidance or retroactive planning, and had been treated consistently on filed returns. The IRS found the termination inadvertent and ruled that the corporation would continue to be treated as an S corporation, subject to normal adjustments and continued eligibility.

Ruling snapshot

• Question: May the corporation retain S status after its stock was temporarily held by two ineligible partnership shareholders?
• Outcome: approved
• Key authorities: IRC §§ 1361, 1362(d) and (f), and 1366 through 1368

Full text (IRS public release)

Internal Revenue Service                                          Department of the Treasury
                                                                  Washington, DC 20224

Number: 201801007                                                 Third Party Communication: None
Release Date: 1/5/2018                                            Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.01-00
                                                                  Person To Contact:
---------------------------------                                 ------------------------------,
-------------------------------------                             ID No. ----------------
----------------------------------                                Telephone Number:
-----------------------------                                     ----------------------
                                                                  Refer Reply To:
                                                                  CC:PSI:B01
                                                                  PLR-114068-17
                                                                  Date:
                                                                  October 10, 2017

LEGEND

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

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

Partnership 1              =         -----------------------------
------------------------------------------------------------

Partnership 2              =         ----------------------------------
------------------------------------------------------------

State                      =        ---------

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

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

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

Month                      =        -----------------

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

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

PLR-114068-17                                2

      This responds to a letter dated April 25, 2017, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under §
1362(f) of the Internal Revenue Code (the Code).

Facts

        According to the information submitted, X was incorporated under the laws of
State on Date 1. X elected to be treated as an S corporation effective Date 2. On Date
3, all of the shares in X were transferred to Partnership 1, a partnership for federal tax
purposes. Partnership 1, as a partnership, was an ineligible shareholder of an S
corporation. Shortly thereafter, Partnership 1 transferred all of its shares in X to
Partnership 2. Partnership 2, as a partnership, was also an ineligible shareholder of an
S corporation. In Month, X learned that the transfer of stock to Partnership 1 terminated
X’s S election. On Date 4, X and its shareholders took remedial action by having
Partnership 2 transfer all of its shares in X to Y, an eligible S corporation shareholder.
After Date 4, all income and other items from the X shares was allocated to Y. Between
Date 3 and Date 4, all the partners of Partnership 1 and Partnership 2 were eligible
shareholders of an S corporation.

       X represents that it did not intend for its S corporation election to terminate and
that the events that resulted in the termination were not motivated by tax avoidance or
retroactive tax planning. X represents that all shareholders filed their returns consistent
with X being an S corporation. Further, X and its shareholders agree to make any
adjustments required by the Secretary consistent with the treatment of X as an S
corporation.

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) defines a “small business corporation” as a domestic
corporation that is not an ineligible corporation and that 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 one
class of stock.

      Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be
terminated whenever the corporation ceases to be a small business corporation.

      Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a)
by any corporation was terminated under paragraph (2) or (3) of § 1362(d), (2) the

PLR-114068-17                               3

Secretary determines that the circumstances resulting in such termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in termination, steps were taken so that the corporation is once
more a small business corporation, 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 any adjustments (consistent with the treatment of the
corporation as an S corporation) as may be required by the Secretary with respect to
the period, then, notwithstanding the circumstances resulting in the termination, the
corporation will be treated as continuing to be an S corporation during the period
specified by the Secretary.

Conclusion

       Based solely on the information submitted and the representations made, we
conclude that X’s S election terminated on Date 3, when all of the shares of X stock
were transferred to Partnership 1. We further conclude that the termination was
inadvertent within the meaning of § 1362(f).

        Accordingly, under § 1362(f), X will be treated as continuing to be an S
corporation on and after Date 3, provided that X’s S corporation election was valid and
not otherwise terminated under § 1362(d). Partnership 1 and Partnership 2 will be
treated as the shareholders of X from Date 3 until Date 4, at which point Y will be
treated as the shareholder. Accordingly, the shareholders of X must include in income
their pro rata share of the separately stated and nonseparately computed items of X as
provided in § 1366, make an adjustments to basis as provided in § 1367, and take into
account any distributions made by X as provided in § 1368.

       Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed concerning whether X is
otherwise eligible to be treated as an S corporation.

PLR-114068-17                                 4

      This ruling is directed only to the taxpayer who requested it. According to §
6110(k)(3), this ruling 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 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 of this letter for section 6110 purposes

cc: