IRA ownership caused an inadvertent S corporation termination

Plain-English summary

An S corporation shareholder transferred company stock to individual retirement accounts, which were not eligible S corporation shareholders. That transfer terminated the company's S election. After discovering the problem, the company redeemed all shares owned by the IRAs and represented that the termination was inadvertent rather than tax-motivated. During the affected period, income attributable to the IRAs had been allocated to their beneficiaries as if those beneficiaries owned the shares directly. The IRS granted inadvertent-termination relief and treated the company as continuously maintaining S corporation status, provided its election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Question: Could the corporation retain S status after stock was transferred to ineligible IRA shareholders?
• Outcome: Approved as an inadvertent termination.
• Key authorities: IRC §§ 1361 and 1362(d), (f).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201817015 Third Party Communication: None
Release Date: 4/27/2018 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00,
1362.01-00, 1362.02-00 Person To Contact:
---------------------------, ID No. ---------------
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---------------------------------------- Telephone Number:
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------------------------------------------ Refer Reply To:
CC:PSI:B03
PLR-130168-17
Date:
January 24, 2018

LEGEND

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

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

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

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

n = ----------------------------------------------

Dear -----------------:
PLR-130168-17 2

  This letter responds to a letter dated September 29, 2017 submitted on behalf of

X by X’s authorized representative, requesting a ruling under § 1362(f) of the Internal
Revenue Code.

                                      FACTS

   X was incorporated under the laws of State on Date 1. X made an S corporation

election effective Date 2. On Date 3, A transferred shares of X stock to IRAs. IRAs
were ineligible shareholders and, as a result, X’s S corporation election was terminated.
Upon learning of the termination of its S corporation status, X redeemed all of the X
stock owned by the IRAs.

    X represents that X and its shareholders intended for X to be an S corporation

effective Date 2 and that X has filed all returns consistent with X’s status as an S
corporation since Date 2. X further represents that during n all income of X attributable
to the IRAs was allocated to the IRAs’ respective beneficiaries as though the
beneficiaries owned the stock directly. X represents that the circumstances resulting in
the termination of X’s S corporation election were inadvertent and not motivated by tax
avoidance or retroactive tax planning. X and X’s shareholders agree to make any
adjustments consistent with the treatment of X as an S corporation as may be required
by the Secretary with respect to the period specified by § 1362(f).

                              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 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 1st taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation.

    Section 1362(f) provides, in pertinent 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 circumstances resulting in
such termination, steps were taken so that the corporation for which the termination
occurred is a small business corporation; and (4) the corporation for which the
PLR-130168-17 3

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 the adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to this period, then, notwithstanding the
circumstances resulting in such termination, the corporation shall be treated as 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 corporation election terminated on Date 3 because X had an
ineligible shareholder. We further conclude that the termination was inadvertent within
the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), X will be treated as
continuing to be an S corporation from Date 3, and thereafter, provided that X’s S
corporation election was otherwise valid and has not otherwise terminated under
§ 1362(d).

  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 request for rulings, it is subject to verification on
examination.

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

the federal tax consequences of the facts described above under any other provisions
of the Code, including X’s eligibility to be a valid S corporation.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

                                   Sincerely,


                                   Bradford R. Poston
                                   Special Counsel
                                   Office of the Associate Chief Counsel
                                   (Passthroughs and Special Industries)

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

cc: