LLC gets late classification and S elections plus inadvertent-termination relief

Plain-English summary

An LLC intended to be treated as an S corporation from its formation date, but it did not timely file either its entity-classification election or its S corporation election. Its sole shareholder was also a partnership, which could not be an eligible S corporation shareholder. The LLC and partnership corrected the ownership problem by transferring the shares to three eligible shareholders, and all affected parties consistently treated the company as an S corporation. The IRS gave the LLC 120 days to file Form 8832 electing corporate classification and Form 2553 electing S status, both effective on the intended date. It also found the termination caused by partnership ownership inadvertent under IRC § 1362(f), allowing continuous S corporation treatment if the election was valid and not otherwise terminated. The ruling requires the shareholders to report the corporation's items and make the related basis and distribution adjustments under IRC §§ 1366 through 1368.

Ruling snapshot

• Question: May the LLC make late corporate-classification and S elections and preserve S status despite ownership by an ineligible partnership?
• Outcome: Approved, with both elections due within 120 days
• Key authorities: IRC §§ 1361, 1362(b)(5), 1362(d), 1362(f), 1366, 1367, 1368; Treas. Reg. §§ 301.7701-3, 301.9100-1, 301.9100-3

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 201902020                                               Third Party Communication: None
Release Date: 1/11/2019                                         Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.01-00,
              9100.00-00                                        Person To Contact:
                                                                ------------------------------,
--------------------                                            ID No. ----------------
-----------------------------------------                       Telephone Number:
--------------------------                                      ----------------------
------------------------------------------                      Refer Reply To:
                                                                CC:PSI:B01
                                                                PLR-107010-18
                                                                Date:
                                                                August 31, 2018


LEGEND

X                          =         ----------------------
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A                          =         ------------------------------
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B                          =         -----------------------
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C                          =         ------------------------
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Partnership                =         ---------------------------------
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State                      =        --------------

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

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

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

       This responds to a letter dated December 28, 2017, and subsequent
correspondence, submitted on behalf of X by X's authorized representative, requesting
an extension of time under § 301.9100-3 of the Procedure and Administration
Regulations to file an election under § 301.7701-3 to be treated as a corporation for
federal tax purposes, relief to make a late S corporation election under relief under §

1362(b)(5) of the Internal Revenue Code (the Code), and relief under § 1362(f) of the
Code.

Facts

        According to the information submitted, X was formed under the laws of State on
Date 1 as a limited liability company. X's shareholder intended that X elect S
corporation treatment effective Date 1. However, X’s Form 2553, Election by a Small
Business Corporation, was not timely filed. In addition, X discovered that its sole
shareholder, Partnership, was an ineligible S corporation shareholder. On Date 2, X
and Partnership took remedial action by having Partnership transfer all of its shares in X
to eligible S corporation shareholders A, B, and C. Between Date 1 and Date 2, all the
partners of Partnership 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.

Rulings Requested

       1. X requests an extension of time under § 301.9100-3 of the Procedure and
Administration Regulations for X to make a late entity classification election to be
treated as an association taxable as a corporation effective Date 1;

       2. X requests relief for X to make a late S corporation election under § 1362(b)(5)
of the Code effective Date 1; and

        3. X requests relief under § 1362(f) of the Code.

Ruling 1

        Section 301.7701-3(a) provides that a business entity that is not classified as a
corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can
elect its classification for federal tax purposes. Elections are necessary only when an
eligible entity does not want to be classified under its default classification or when an
eligible entity chooses to change its classification.

      Section 301.7701-3(b)(1) provides that, unless the entity elects otherwise, a
domestic eligible entity is (i) a partnership if it has two or more members; or (ii)
disregarded as an entity separate from its owner if it has a single owner.

        Section 301.7701-3(c)(1)(i) provides that an eligible entity may elect to be
classified other than as provided under § 301.7701-3(b) by filing Form 8832 with the
appropriate service center. Under § 301.7701-3(c)(1)(iii), this election will be effective
on the date specified by the entity on Form 8832 or on the date filed if no such date is
specified. The date specified on Form 8832 cannot be more than 75 days prior to the
date on which the election is filed.

       Section 301.9100-1(c) provides that the Commissioner may grant a reasonable
extension of time to make a regulatory election, or a statutory election (but no more than
6 months except in the case of a taxpayer who is abroad), under all subtitles of the
Code except subtitles E, G, H, and I. Section 301.9100-1(b) provides that the term
“regulatory election” includes an election whose due date is prescribed by a regulation
published in the Federal Register.

       Sections 301.9100-1 through 301.9100-3 provide the standards the
Commissioner will use to determine whether to grant an extension of time to make the
election. Section 301.9100-2 provides the rules governing automatic extensions of time
for making certain elections. Section 301.9100-3 provides the standards the
Commissioner will use to determine whether to grant an extension of time for regulatory
elections that do not meet the requirements of § 301.9100-2.

        Under § 301.9100-3, a request for relief will be granted when the taxpayer
provides the evidence (including affidavits described in § 301.9100-3(e)) to establish to
the satisfaction of the Commissioner that (1) the taxpayer acted reasonably and in good
faith, and (2) the grant of relief will not prejudice the interests of the Government.

        Based solely on the information submitted and the representations made, we
conclude that X has satisfied the requirements of §§ 301.9100-1 and 301.9100-3. As a
result, X is granted an extension of time of 120 days from the date of this letter to file a
Form 8832 with the appropriate service center and elect to be treated as an association
taxable as a corporation for federal tax purposes, effective Date 1. A copy of this letter
should be attached to the Form 8832.

Ruling 2

      Section 1362(a) provides that a small business corporation may elect to be an S
corporation.

      Section 1362(b) provides the rule on when an S election will be effective. Section
1362(b)(1) provides in relevant part that if an S election is made within the first two and
one-half months of a corporation's taxable year, then the corporation will be treated as
an S corporation for the year in which the election is made. Under § 1362(b)(3),
however, if an S election is made after the first two and one-half months of a

corporation's taxable year, then that corporation will not be treated as an S corporation
until the taxable year after the year in which the S election is filed.

       Section 1362(b)(5) provides that if: (A) an election under § 1362(a) is made for
any taxable year after the date prescribed by § 1362(b) for making such election for
such taxable year or no such election is made for any taxable year, and (B) the
Secretary determines that there was reasonable cause for the failure to timely make
such election, then the Secretary may treat such an election as timely made for such
taxable year.

        Based solely on the facts submitted and the representations made, we conclude
that X has established reasonable cause for failing to make a timely election to be an S
corporation effective Date 1. Accordingly, provided that X makes an election to be an S
corporation by filing a completed Form 2553 effective Date 1, along with a copy of this
letter, with the appropriate service center within 120 days from the date of this letter,
then such election will be treated as timely made for Date 1.

Ruling 3

        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
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.

        Based solely on the information submitted and the representations made, we
conclude that X's S election terminated on Date 1, when all of the shares of X stock
were owned by Partnership. 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 1, provided that X's S corporation election was valid and
not otherwise terminated under § 1362(d). Partnership will be treated as the
shareholder of X from Date 1 until Date 2, at which point A, B, and C will be treated as
the shareholders. 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.

      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,


                                          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