Corporation receives relief for missing consent and ineligible shareholder

Plain-English summary

A corporation's S election was invalid because the spouse of a shareholder, who held a community-property interest, did not consent on Form 2553. The corporation's stock ledger later also showed shares owned by a corporation, which was an ineligible S corporation shareholder. The corporation represented that neither defect was intended, that it and its shareholders consistently filed as an S corporation, and that the problems were not motivated by tax avoidance or retroactive planning. The corporation and shareholders agreed to make any adjustments required by the IRS. The IRS treated both the invalid election and the later termination as inadvertent under section 1362(f), allowing S corporation treatment from the intended effective date if the election was otherwise valid and remained in effect.

Ruling snapshot

• Question: Could the corporation preserve S status despite a missing required shareholder consent and a later ineligible corporate shareholder?
• Outcome: Approved.
• Key authorities: IRC §§ 1361 and 1362; Rev. Proc. 2019-1.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202001001 Third Party Communication: None
Release Date: 1/3/2020 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.01-00,
1362.01-01 Person To Contact:
------------------, ID No. ------------------
Telephone Number:
---------------------- ----------------------
---------------------------------------------- Refer Reply To:
-------------------------------------- CC:PSI:B01
------------------------------------ PLR-102041-19
Date:
August 09, 2019

Legend:

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

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

A = ---------------

B = ----------------

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

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

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

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

This responds to a letter signed December 20, 2018, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under
§ 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted and representations within, X was formed on
Date 1, under the laws of State. Effective Date 2, X elected to be taxed as an S
PLR-102041-19 2

corporation. However, the required consent to X’s S corporation election on Form 2553
was not obtained from A, who had community property shares in X by virtue of being
the spouse of B, an X shareholder, resulting in an inadvertent invalid election.

Furthermore, it was discovered that on Date 3, X’s stock ledger indicates a change in
B’s stock ownership in X. The ledger was changed from direct individual ownership by
B to reflect ownership by a corporation, an ineligible shareholder.

X represents that it intended to make a valid S corporation election effective Date 2 and
that the ineffectiveness of the election was inadvertent and not motivated by tax
avoidance or retroactive tax planning. X further represents that neither X nor its
shareholders intended to terminate X’s Subchapter S election on Date 3, and that X and
its shareholders have filed consistently with being an S corporation. In addition, X
represents that, other than the termination due to an ineligible shareholder listed on the
company stock ledger and the lack of consent of a required shareholder on the original
Form 2553, X has qualified as a small business corporation at all times since its election
on Date 2. Lastly, 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) as may be required by the Secretary.

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,
and a trust described in subsection (c)(2), or an organization described in subsection
(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(d)(2)(B) further provides that the termination shall be effective
on and after the date of cessation.

Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
corporation was not effective for the taxable year made (determined without regard to
§ 1362(b)(2)) by reason of failure to obtain shareholder consents, or was terminated
under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting
in the ineffectiveness or termination were inadvertent, (3) no later than a reasonable
period of time after the discovery of the circumstances resulting in the ineffectiveness or
termination, steps were taken so that the corporation for which the election was made or
PLR-102041-19 3

termination occurred is a small business corporation, and (4) the corporation for which
the election was made or the termination occurred, and each person who was a
shareholder in such corporation at any time during the period of inadvertent
ineffectiveness or termination of the S election, 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 or termination, the corporation is treated
as an S corporation during the period specified by the Secretary.

Section 6.11 of Revenue Procedure 2019-1, I.R.B. 2019-1, 22, provides that, with an
exception not relevant here, a letter ruling will not be issued with respect to an issue that
is clearly and adequately addressed by statute, regulations, decision of a court, revenue
rulings, revenue procedures, notices, or other authority published in the Internal
Revenue Bulletin (Comfort Ruling). However, with certain exceptions not relevant here,
the Associate office may, in its discretion, decide to issue a Comfort Ruling if the
Associate office is otherwise issuing a letter ruling to the taxpayer on another issue
arising in the same transaction.

CONCLUSION

Based on the facts submitted and the representations made, we first conclude that X’s
S corporation election was invalid because A did not consent to the election. However,
we also conclude that the invalidity of X’s S corporation election was inadvertent within
the meaning of § 1362(f). We further conclude that, if X’s election had not been
ineffective, it would have terminated on Date 3 because of the ownership of shares by
an ineligible shareholder, and that the termination would have been 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 was otherwise valid and 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 who requested it. According to § 6110(k)(3),
this ruling may not be used or cited as precedent.

The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.
PLR-102041-19 4

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to your authorized representative.

                                  Sincerely,


                                  Joy C. Spies
                                  Joy C. Spies
                                  Senior Technician Reviewer, Branch 1
                                  IRS Office of Chief Counsel
                                  (Passthroughs & Special Industries)

Enclosures (2)

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