IRS consents to an early entity-classification change after an ownership shift

Plain-English summary

A limited liability company started out with a single owner, so by
default it was a "disregarded entity" (ignored for tax, its income
reported by the owner). It then elected to be taxed as an S corporation,
which under the check-the-box rules also made it a "deemed" association
taxable as a corporation. Later, a new owner bought all of the LLC's
interests. The taxpayer wanted to switch the entity back to a disregarded
entity, but the classification rules normally bar an entity from changing
its election again within 60 months of the last change. There is an
exception: the IRS may permit an earlier change if more than 50% of the
ownership interests are now held by persons who did not own any interest
at the time of the prior election. Because the sale shifted more than 50%
of ownership, the IRS consented under Treas. Reg. § 301.7701-3(c)(1)(iv)
to reclassify the LLC as a disregarded entity effective the requested
date, directing it to file Form 8832. This matters to buyers of S
corporations and LLCs who want to change the target's tax classification
soon after the acquisition.

Ruling snapshot

• Question: May the entity change its classification to a disregarded
  entity within the 60-month window, given the more-than-50% ownership
  change?
• Outcome: Approved (IRS consents; entity to file Form 8832 under Rev.
  Proc. 2009-41)
• Key authorities: Treas. Reg. § 301.7701-3(a), (b), (c)(1)(i)-(v);
  IRC §§ 1362(a)(1), 1361(b); Rev. Proc. 2009-41

Full text (IRS public release)

Internal Revenue Service                     Department of the Treasury
                                             Washington, DC 20224

Number: 202050005                            Third Party Communication: None
Release Date: 12/11/2020                     Date of Communication: Not Applicable
Index Number: 7701.00-00

Person To Contact:
------------------------, ID No. -----------------
Telephone Number:
--------------------
Refer Reply To:
CC:PSI:B03
PLR-107585-20
Date:
September 15, 2020

Legend

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

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

Date1             =        ----------------

Date2             =        ---------------------

Date3             =        -------------------

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

        This letter responds to a letter dated March 4, 2020, submitted on behalf of X,
requesting a ruling under § 301.7701-3(c)(1)(iv) of the Procedure and Administration
Regulations. Specifically, your letter requests the Service's consent to change X's
entity classification from an association taxable as a corporation to a disregarded entity
for federal tax purposes effective Date3.


                                     FACTS

       The information submitted states that X was formed under the laws of State as a
limited liability company in Date1. At the time of formation, X had a single owner and
was treated as a disregarded entity for federal tax purposes. X subsequently elected to
be an S corporation effective Date2. Under § 301.7701-3(c)(i)(v)(C), X is treated as
having made an election to be classified as an association taxable as a corporation for
federal tax purposes effective Date2. On Date3, a new owner acquired all of the
outstanding interests in X. X represents that as of Date3, X had a change of ownership
of more than fifty percent that would satisfy § 301.7701-3(c)(1)(iv).

                              LAW AND ANALYSIS

        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 as provided in § 301.7701-3. Elections
are necessary only when an eligible entity does not want to be classified under the
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, except as provided in § 301.7701-
3(c)(1)(iv) and (v), an eligible entity may elect to be classified other than as provided
under § 301.7701-3(b), or to change its classification, by filing Form 8832, Entity
Classification Election, with the service center designated on Form 8832.

        Section 301.7701-3(c)(1)(iii) provides that an election made under § 301.7701-
3(c)(1)(i) will be effective on the date specified by the entity on the Form 8832 or on the
date filed if no date is specified on the election form. The effective date specified on
Form 8832 cannot be more than 75 days prior to the date on which the election is filed
and cannot be more than 12 months after the date on which the election is filed.

        Section 301.7701-3(c)(1)(iv) provides that, if an eligible entity makes an election
under § 301.7701-3(c)(1)(i) to change its classification, the entity cannot change its
classification by election again during the sixty months succeeding the effective date of
the election. However, the Commissioner may permit the entity to change its
classification by election within the sixty months if more than fifty percent of the
ownership interests in the entity as of the effective date of the subsequent election are
owned by persons that did not own any interests in the entity on the filing date or on the
effective date of the entity's prior election.

       Section 301.7701-3(c)(i)(v)(C) provides that an eligible entity that timely elects to
be an S corporation under § 1362(a)(1) of the Internal Revenue Code (Code) is treated as having made an election under
§ 301.7701-3 to be classified as an association, provided that (as of the effective date of
the election under § 1362(a)(1)) the entity meets all other requirements to qualify as a
small business corporation under § 1361(b). Subject to § 301.7701-3(c)(1)(iv), the
deemed election to be classified as an association will apply as of the effective date of
the S corporation election and will remain in effect until the entity makes a valid election,
under § 301.7701-3(c)(1)(i), to be classified as other than an association.

                                CONCLUSION

       Based solely on the information submitted and the representations made, we
consent to X changing its entity classification to a disregarded entity for federal tax
purposes effective Date3 under § 301.7701-3(c)(1)(iv). Accordingly, X should file a
Form 8832 pursuant to Rev. Proc. 2009-41, 2009-39 I.R.B. 439, with the appropriate
service center to elect to be disregarded as an entity separate from its owner effective
Date3 and attach a copy of this letter to its Form 8832.

        Except as expressly provided herein, we express or imply no opinion concerning
the federal tax consequences of any transaction or item discussed or referenced in this
letter. Specifically, we express or imply no opinion regarding whether X is otherwise
eligible to make the election.

       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.

      This ruling is directed only to the taxpayer requesting it. According to
§ 6110(k)(3) of the Code, this ruling may not be used or cited as precedent.

      In accordance with the power of attorney on file with this office, we are sending
copies of this letter to X's authorized representatives.


                                         Sincerely,



                                         Mary Beth Carchia
                                         Senior Technician Reviewer, Branch 3
                                         Office of the Associate Chief Counsel
                                         (Passthroughs & Special Industries)



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

cc: