Partnership shareholder made S election inadvertently ineffective

Plain-English summary

A corporation intended to elect S status while a limited liability company taxed as a partnership owned some of its stock. Because a partnership cannot be an S corporation shareholder, the election was ineffective from its intended effective date. After discovering the error, the LLC promptly transferred all shares to its two individual partners, who were eligible shareholders. The corporation and its owners had consistently filed as though the S election were valid and agreed to make any required adjustments. The IRS found the mistake inadvertent and treated the corporation as continuously qualifying from the intended election date, assuming the election was otherwise valid and did not terminate for another reason.

Ruling snapshot

• Question: Was an S election inadvertently ineffective because a partnership held the corporation's stock?
• Outcome: Approved. The corporation is treated as an S corporation from the intended effective date.
• Key authorities: IRC §§ 1361(b)(1)(B), 1362(d)(2), 1362(f), 1366, 1367, 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202124001 [Third Party Communication:
Release Date: 6/18/2021 Date of Communication: Month DD, YYYY]
Index Number: 1362.04-00
Person To Contact:
--------------------------- --------------------------, ID No. -------------
---------------- Telephone Number:
---------------------------------------- --------------------
-------------------------------- Refer Reply To:
CC:PSI:B01
PLR-113147-20
Date:
December 03, 2020

LEGEND:
X = ----------------------------------------------------------------------------------------
---------------------------------

LLC = ----------------------------------------------------------------------------------------
---------------------------------

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

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

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

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

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

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

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

This letter responds to a letter dated June 1, 2020, and subsequent correspondence,
submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue
Code.

                                                  FACTS

The information submitted states that X was formed under the laws of State on Date 1
and elected to be treated as an S corporation effective Date 2. On Date 2, LLC, a
partnership for federal tax purposes, held shares of X stock. LLC, as a partnership, is an
PLR-113147-20 2

ineligible shareholder of an S corporation. Therefore, X’s S corporation election was
ineffective.

X represents that upon discovery of its error, it promptly took remedial action. Effective
Date 3, LLC transferred all of its shares of X stock to A and B, individual partners of
LLC. X represents that both A and B are eligible S corporation shareholders.

X represents that the circumstances surrounding X’s ineffective S corporation election
were inadvertent and unintended. X further represents that for each taxable year since
Date 2, X and its shareholders have filed consistently with X being an S corporation. In
addition, X and its shareholders agree to make any adjustments required as a condition
of obtaining relief under § 1362(f) as may be required by the Secretary.

                              LAW AND ANALYSIS

Section 1361(a)(1) of the Code 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 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 one
class of stock.

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) by any corporation (A)
was not effective for the tax 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 (B) was terminated under paragraph (2) or (3) of § 1362(d); (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 event resulting in the ineffectiveness or termination, steps were taken
(A) so that the corporation is a small business corporation, or (B) to acquire the required
shareholder consents, 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 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,
PLR-113147-20 3

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.

                                 CONCLUSION

Based on the facts submitted and representations made, we conclude that X’s
S corporation election intended to be effective on Date 2 was ineffective because LLC
was an ineligible S corporation shareholder under § 1361(b)(1)(B). We further conclude
that such ineffectiveness 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 otherwise valid and has
not terminated under § 1362(d). Accordingly, the shareholders of X must include in
income their pro rata share of the separately stated and nonseparately stated items of X
as provided in § 1366, make any adjustments to stock basis as provided in § 1367, and
take into account any distributions made by X as provided in § 1368.

Except for the specific ruling above, we express no opinion concerning the federal tax
consequences of the facts described above under any other provision of the Code.
Specifically, no opinion is expressed concerning whether X was otherwise eligible to be
treated as an 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-113147-20 4

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent
to X’s authorized representative.

                                   Sincerely,

                                   Laura C. Fields

                                   Laura C. Fields
                                   Senior Technician Reviewer, Branch 1
                                   (Passthroughs & Special Industries)

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

cc: