IRS grants relief for an inadvertently terminated QSub election

Plain-English summary

An S corporation had elected to treat a wholly owned subsidiary as a qualified
subchapter S subsidiary (a QSub), which lets the subsidiary be ignored as a
separate corporation for tax purposes and folded into the parent's S corporation
return. A QSub election requires the S corporation to own 100 percent of the
subsidiary's stock. Here the subsidiary later issued and sold shares to an outside
party, which broke the 100 percent ownership and automatically terminated the QSub
election. When the company discovered the problem, it took corrective action to put
the subsidiary's assets and liabilities back with the S corporation. The IRS ruled
that the termination was inadvertent under Code Section 1362(f) and that the
subsidiary will be treated as a QSub from its original effective date through a
later specified date, as long as the parent's S corporation election stayed valid.
This is standard inadvertent-termination relief that preserves a QSub's tax status
despite a technical slip.

Ruling snapshot

• Question: Was the termination of the subsidiary's QSub election inadvertent, qualifying it for relief under Code Section 1362(f)?
• Outcome: Approved (termination ruled inadvertent; QSub treatment restored)
• Key authorities: IRC § 1362(f); IRC § 1361(b)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201850018 Third Party Communication: None
Release Date: 12/14/2018 Date of Communication: Not Applicable
Index Number: 1362.04-00 Person To Contact:
---------------------------, ID No. ------------------
---------------------------------- -------------------------------------------------------
---------------------------------------------- Telephone Number:
---------------------------- ----------------------
-------------- Refer Reply To:
------------------------------ CC:PSI:B03
PLR-112677-18
Date: September 14, 2018

     LEGEND:

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

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

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

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

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

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

Date 5 = ---------------------------

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

Z = -----------------------------------------------------------------
-------------------------

N = ------------
2
PLR-112677-18

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

  This responds to a letter dated April 6, 2018, on behalf of X by its authorized

representative requesting a ruling under § 1362(f) of the Internal Revenue Code.

                                     FACTS

   X was organized on Date 1 as a corporation under the laws of State. Effective

Date 2, Y filed an election to treat X as a qualified subchapter S subsidiary (QSub).
Originally, Y, an S corporation, owned all of the shares of X.

   On Date 3, X entered into a subscription agreement with Z pursuant to which it

issued and sold N additional shares of common stock to Z. Various other sales and
transfers of X stock to persons other than Y occurred prior to Date 4.

      On Date 4, X learned that the transfer of its shares to Z terminated its QSub

status. In response, X and Y took corrective action to ensure that all the assets,
liabilities, and items of income, deduction and credit of X became and were once more
the assets, liabilities, and items of income, deduction and credit of Y.

    X represents that X and Y intended for X to be a QSub effective Date 2. X and

its current and former shareholders agree to make any adjustments required as a
condition of obtaining relief under the inadvertent termination rule as provided in
§ 1362(f).

                              LAW AND ANALYSIS

  Section 1361(b)(3)(A) provides that a QSub shall not be treated as a separate

corporation, and 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) defines a QSub as a domestic corporation which is not an

ineligible corporation, if 100 percent of the stock of the corporation is owned by the S
corporation, and the S corporation elects to treat the corporation as a QSub.

   Section 1362(f) provides, in relevant part, that if: (1) an election under § 1362(a)

or § 1361(b)(3)(B)(ii) by any corporation was terminated under § 1362(d)(2) or (3) or
§ 1361(b)(3)(C); (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 QSub; and (4) the corporation for
which the termination occurred, and each person who was a shareholder of the
PLR-112677-18 3

corporation at any time during the period specified pursuant to § 1362(f), agree to make
the adjustments (consistent with the treatment of the corporation as a QSub) 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 a QSub
during the period specified by the Secretary.

                                  CONCLUSION

   Based on the facts submitted and the representations made, we conclude that

X's QSub election terminated on Date 3 when X transferred shares of X stock to Z.
However, we conclude that such termination was inadvertent within the meaning of
§ 1362(f). Therefore, X will be treated as a QSub from Date 2 through Date 5, provided
Y's S corporation election was valid and has not terminated under § 1362(d) and that
X's QSub election was valid and, apart from the inadvertent termination ruling described
above, has not otherwise terminated.

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

concerning the federal tax consequences of the facts described above under any other
provision of the Code. Specifically, we express or imply no opinion regarding X's
eligibility to be a QSub.

  The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and is 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 this request, it is subject to verification on examination.

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

provides that this ruling may not be used or cited as precedent.

    Pursuant to a power of attorney on file with this office, we are sending copies of

this letter to your authorized representatives.

                                          Sincerely,


                                          James A. Quinn
                                          Senior Counsel, Branch 3
                                          Office of the Associate Chief Counsel
                                          (Passthroughs and Special Industries)

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

CC: