Inadvertent ineligible shareholder did not end S status

Plain-English summary

An S corporation transferred shares to an ineligible shareholder, which caused its S election to terminate. After discovering the problem, the corporation and its shareholders transferred the shares to eligible shareholders. They represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive planning, and that all returns had treated the company as an S corporation. The IRS granted inadvertent-termination relief under Section 1362(f). The company will continue to be treated as an S corporation from its original election date, provided its election is not otherwise terminated.

Ruling snapshot

• Question: May the corporation retain S status after shares were temporarily held by an ineligible shareholder?
• Outcome: approved
• Key authorities: IRC §§ 1361(a), 1361(b), 1362(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201831001 Third Party Communication: None
Release Date: 8/3/2018 Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.01-00,
1361.01-02 Person To Contact:
-------------------, ID No. ------------------
-------------------------------------------------- Telephone Number:
----------------------------------------- --------------------
---------------------------------- Refer Reply To:
------------------------------------------------ CC:PSI:B01
PLR-100990-18
Date:
April 11, 2018

LEGEND

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

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

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

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

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

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

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

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

This responds to a letter dated September 25, 2017, submitted on behalf of X, by X’s
authorized representative, requesting relief under section 1362(f) of the Internal
Revenue Code (the Code) for an inadvertent invalid S election.

FACTS
PLR-100990-18 2

According to the information submitted and representations made within, X was
incorporated on Date 1 and made an S election effective Date 2, under the laws of
State.

On or around Date 3, shares of X were transferred to Y, an ineligible shareholder; thus
causing X’s S election to terminate. On Date 4, X and its shareholders took corrective
action, transferring the X shares from Y to eligible shareholders.

X represents that the termination of its S election was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. X also represents that X and its
shareholders agree to make any adjustments required as a condition of obtaining relief
under the inadvertent termination rule as provided under § 1362(f) of the Code that may
be required by the Secretary. X and its shareholders represent that they have filed all
returns consistently X with being 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 the year. Section 1361(b)(1) defines a “small business corporation” as a
domestic corporation which is not an ineligible corporation 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, in part, that if (1) an election under § 1362(a) by any
corporation was not effective for the taxable year for which made by reason of a failure
to meet the requirements of § 1361(b), (2) the Secretary determines that the
circumstances resulting in the ineffectiveness were inadvertent, (3) no later than a
reasonable period of time after the discovery of the circumstances resulting in the
ineffectiveness, steps were taken so that the corporation for which the election was
made is a small business corporation, and (4) the corporation for which the election was
made, and each person who was a shareholder in such corporation at any time during
the period specified by § 1362(f), agrees to makes 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, the corporation is treated as an S corporation during the period
specified by the Secretary.
PLR-100990-18 3

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the termination of X’s S corporation election was inadvertent within the meaning of §
1362(f). Therefore, X will be treated as an S corporation effective Date 2 and thereafter,
provided X’s S corporation election is not otherwise terminated under § 1362(d).

Except as specifically ruled upon above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation.

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
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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

cc: