LLC received inadvertent S corporation election relief after fixing its operating agreement

Plain-English summary

A limited liability company elected S corporation status, but its operating agreement contained partnership provisions that created more than one class of stock. The members later amended the agreement so that every member had identical distribution and liquidation rights. The company represented that the defect was inadvertent, no return had been filed inconsistently with S corporation treatment, and all income and distributions had been allocated pro rata. The company and its shareholders also agreed to make any adjustments required by the IRS. The IRS granted relief under section 1362(f) and treated the company as an S corporation from the intended effective date, assuming the election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Question: Can an LLC's ineffective S corporation election be treated as valid when its operating agreement unintentionally created a second class of stock?
• Outcome: approved, because the defect was inadvertent and the operating agreement was corrected
• Key authorities: IRC §§ 1361(b)(1)(D), 1362(f); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201944007                                             Third Party Communication: None
Release Date: 11/1/2019                                       Date of Communication: Not Applicable
Index Number: 7701.02-00
                                                              Person To Contact:
-----------------------------------                           ---------------------------, ID No. ---------------
----------------------------------------------------          -----------------
----------------------------------------------                Telephone Number:
--------------------------------------                        ---------------------
                                                              Refer Reply To:
                                                              CC:PSI:B03
                                                              PLR-103637-19
                                                              Date:
                                                              August 01, 2019


                                                       LEGEND

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

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

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

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

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

Operating Agreement                          = ---------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------- ----
--------------------------------------

Amended Operating Agreement = --------------------------------------------------------- ---------
-------------------------------------


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

This letter responds to a letter dated January 11, 2019, submitted on behalf of X by its
authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue
Code.

                                                       FACTS

The information submitted states that X was organized as a limited liability company
under the laws of State on Date 1. X elected to be an S corporation effective Date 2.

PLR-103637-19                                 2

However, on Date 2, X's Operating Agreement included provisions regarding
partnerships that caused X to have more than one class of stock. On Date 3, X’s
members adopted the Amended Operating Agreement, which provided identical
distribution and liquidation rights to X's members.

X represents that X's ineffective S corporation election was inadvertent and not the
result of retroactive tax planning. X further represents that no federal tax return of any
person has been filed inconsistent with a valid S corporation election having been made
for X effective Date 2. X also represents that all distributions and allocations of income
to its shareholders have been made pro rata in accordance with their interests in X. X
and X's shareholders have agreed to make any adjustments required by the Service
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
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 one class of stock.

Section 1362(a)(1) provides that, except as provided in § 1362(g), a small business
corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

Section 1362(d)(2)(A) provides that an election under § 1362(a) is terminated whenever
(at any time on or after the first day of the first taxable year for which the corporation is
an S corporation) such corporation ceases to be a small business corporation. Section
1362(d)(2)(B) provides that any termination under § 1362(d)(2)(A) is effective on and
after the date of cessation.

Section 1362(f) provides that if (1) an election under § 1362(a) or § 1361(b)(3)(B)(ii) by
any corporation (i) was not effective for the taxable year for which made (determined
without regard to § 1362(b)(2)) by reason of a failure to meet the requirements of
§ 1361(b) or to obtain shareholder consents, or (ii) was terminated under § 1362(d)(2)
or (3) or § 1361(b)(3)(C); (2) the Secretary determines that the circumstances resulting
in such ineffectiveness or termination were inadvertent; (3) no later than a reasonable
period of time after discovery of the circumstances resulting in such ineffectiveness or
termination, steps were taken so that the corporation for which the election was made or
the termination occurred is a small business corporation; and (4) the corporation for

PLR-103637-19                                 3

which the election was made or the termination occurred, and each person who was a
shareholder of the 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 an S corporation) as may be required by the Secretary with respect to
this period, then, notwithstanding the circumstances resulting in such ineffectiveness or
termination, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

Section 1.1361-1(l)(1) of the Income Tax Regulations provides, in part, that a
corporation is generally treated as having only one class of stock if all outstanding
shares of stock of the corporation confer identical rights to distribution and liquidation
proceeds.

Section 1.1361-1(l)(2)(i) provides that the determination of whether all outstanding
shares of stock confer identical rights to distribution and liquidation proceeds is made
based on the corporate charter, articles of incorporation, bylaws, applicable state laws,
and binding agreements relating to distribution and liquidation proceeds (collectively,
governing provisions).

                                      CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X's S
corporation election was ineffective on Date 2 because X had more than one class of
stock due to the provisions in the Operating Agreement. We also conclude that the
ineffectiveness of X's S corporation election was inadvertent within the meaning of
§ 1362(f). Accordingly, under the provisions of § 1362(f), X will be treated as an S
corporation from Date 2 and thereafter, provided that X's S corporation election was
otherwise valid and not otherwise terminated under § 1362(d).

Except as specifically set forth above, we express no opinion concerning the federal
income tax consequences of the facts described above under any other provision of the
Code.

This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

Pursuant to a power of attorney on file, we are sending a copy of this letter to X's
authorized representative.

PLR-103637-19                               4

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 rulings requested, it is subject to verification on examination.



                                     Sincerely,



                                     Caroline E. Hay
                                     Assistant to the Branch Chief, Branch 3
                                     Office of the Associate Chief Counsel
                                     (Passthroughs & Special Industries)


Enclosures: --
      Copy of this letter
      Copy for § 6110 purposes