S corporation receives relief after shares passed to ineligible foreign owners

Plain-English summary

An S corporation's election terminated when shares began being transferred to two nonresident aliens, who were ineligible S corporation shareholders. After discovering the problem, the corporation and its shareholders transferred one owner's shares to an eligible shareholder and redeemed the other owner's stock. They represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive planning, and that returns had been filed consistently with S corporation status. The IRS granted relief under section 1362(f) and treated the corporation as continuing to be an S corporation from the termination date forward. The relief applies only if the original S election was valid and was not otherwise terminated.

Ruling snapshot

• Question: May the corporation retain S corporation treatment after shares were transferred to two ineligible nonresident-alien shareholders?
• Outcome: approved as an inadvertent termination, subject to the election having been valid and not otherwise terminated
• Key authorities: IRC §§ 1361(a) and (b), 1362(d)(2), and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202020016 Third Party Communication: None
Release Date: 5/15/2020 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.01-00,
1362.02-00, 1362.04-00 Person To Contact:
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------------------------------- Refer Reply To:
CC:PSI:B01
PLR-125241-19

                                                             Date:
                                                             January 21, 2020

LEGEND

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

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

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

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

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

Date 5 = ---------------------------
PLR-125241-19 2

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

This responds to a letter dated October 11, 2019, and supplemental correspondence,
submitted on behalf of X, by X's authorized representative, requesting relief under §
1362(f) of the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations made within, X was formed
under the laws of State and made an S election effective Date 1. On Date 2, shares in
X began being transferred to A and B, nonresident aliens, who were ineligible S
corporation shareholders. On Date 3, X discovered that A and B were ineligible
shareholders that caused X's S election to terminate effective Date 2. On Date 4, X and
its shareholders took remedial action by having A transfer all of its shares in X to C, an
eligible S corporation shareholder. On Date 5, X and its shareholders took additional
remedial action by engaging in a redemption of B’s stock in X. As of Date 5, X
represents that all of its shareholders are eligible S corporation shareholders. X was not
profitable at any time between Date 1 and Date 5.

X represents that the circumstances resulting in the termination of X's S corporation
election were inadvertent and not motivated by tax avoidance or retroactive tax
planning. X further represents that it has filed returns consistent with its status as an S
corporation. X and its shareholders have agreed to make any adjustments the
Commissioner may require, 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 the year. Section 1361(b)(1) defines a “small business corporation” as a
domestic corporation which is not an ineligible corporation and 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 that if (1) an election under subsection (a) or section
1361(b)(3)(B)(ii) by any corporation (A) was not effective for the taxable year for which
made (determined without regard to subsection (b)(2)) by reason of a failure to meet the
PLR-125241-19 3

requirements of section 1361(b) or to obtain shareholder consents, or (B) was
terminated under paragraph (2) or (3) of subsection (d) or section 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 (A) so that the corporation for which the election was made or the
termination occurred is a small business corporation or a qualified subchapter S
subsidiary, as the case may be, or (B) to acquire the required shareholder consents;
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 specified pursuant to this subsection, agrees to make such adjustments
(consistent with the treatment of such corporation as an S corporation or a qualified
subchapter S subsidiary, as the case may be) as may be required by the Secretary with
respect to such period, then, notwithstanding the circumstances resulting in such
ineffectiveness or termination, such corporation shall be treated as an S corporation or
a qualified subchapter S subsidiary, as the case may be during the period specified by
the Secretary.

CONCLUSION

Based solely on the information submitted and the representations made, we conclude
that X's S election terminated on Date 2 because X had at least one ineligible
shareholder. 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 2, provided that X's S corporation election was valid and not otherwise
terminated under § 1362(d).

Except as specifically ruled above, we express or imply no opinion as to the federal
income tax consequences of the facts described above under any other provision of the
code, including whether X was otherwise a valid 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.

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-125241-19 4

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                           Sincerely,



                                           David Haglund

                                           David Haglund, Branch Chief
                                           Branch 1
                                           Office of the Associate Chief Counsel
                                           (Passthroughs & Special Industries)

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

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