A botched QSub election is treated as inadvertent, so subsidiary status is preserved

Plain-English summary

An S corporation's sole owner reorganized the business by contributing that company (Sub) to a new holding corporation (X) in a tax-free "F reorganization," so X became the successor S corporation and Sub became its wholly owned subsidiary. On the same day, Sub converted into an LLC, which by default is a disregarded entity, not a corporation. X then filed an election to treat Sub as a qualified subchapter S subsidiary (QSub). That election was ineffective, because a QSub must be a corporation, and Sub was already an LLC when the election took effect. X asked the IRS to treat the failure as inadvertent under section 1362(f). The IRS agreed: it found the ineffective QSub election inadvertent and ruled that Sub will be treated as a QSub as of the intended date, provided that within 120 days Sub files Form 8832 electing to be taxed as a corporation. This matters because a failed QSub election can unravel the intended passthrough structure, and section 1362(f) relief lets taxpayers cure this kind of entity-classification slip without losing the tax treatment they planned.

Ruling snapshot

• Question: Was X's ineffective election to treat Sub (by then an LLC) as a QSub inadvertent under section 1362(f), so Sub can still be treated as a QSub?
• Outcome: Approved (inadvertent ineffectiveness relief granted, contingent on filing Form 8832 within 120 days)
• Key authorities: IRC § 1362(f); § 1361(b)(3)(B); Treas. Reg. § 1.1361-3(a)(1); Rev. Rul. 2008-18

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202204001 Third Party Communication: None
Release Date: 1/28/2022 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------------- -------------------, ID No. ---------------
---------------------------------------------------- Telephone Number:
---------------------------------------- --------------------
------------------------------ Refer Reply To:
---------------------------------- CC:PSI:B03
------------------------- PLR-110066-21
Date:
October 28, 2021

LEGEND:

Sub = ------------------------------------------------------------------

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

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

State 1 = ----------

State 2 = -------------

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

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

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

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

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

  This letter responds to a letter dated April 22, 2021, and subsequent

correspondence, submitted on behalf of X by its authorized representative requesting a
PLR-110066-21 2

ruling under § 1362(f) of the Internal Revenue Code (Code).

                                      FACTS

    The information submitted states that Sub, a State 1 corporation, elected to be

an S corporation effective Date 1. A, the sole shareholder of Sub, formed X, a State 1
corporation, on Date 2. On Date 3, incident to what X represents was part of a
reorganization under § 368(a)(1)(F), A contributed all the stock in Sub to X, thereby
causing Sub to become a wholly owned subsidiary of X. Consistent with Rev. Rul.
2008-18, 2008-1 C.B. 674, X was treated as the successor S corporation to Sub for
federal tax purposes and therefore did not make a new S corporation election. Also, on
Date 3, Sub converted to a State 2 limited liability company and by default was
classified as a disregarded entity for federal tax purposes. On Date 4, X filed an
election to treat Sub as a qualified subchapter S subsidiary (“QSub”) effective Date 3.
However, X’s election to treat Sub as a QSub was ineffective because Sub was not a
corporation (as defined by § 301.7701-2(b) of the Procedure and Administration
Regulations) on Date 3, and therefore, failed to meet all the requirements of
§ 1361(b)(3)(B) at the time the election was made and for all periods for which the
election was to be effective.

   X represents that the ineffective QSub election was inadvertent and not the result

of tax avoidance or retroactive tax planning. X and Sub agree to make any adjustments
that may be required by the Secretary under 1362(f) consistent with the treatment of
Sub as a QSub, including filing Form 8832, Entity Classification Election, electing to
classify Sub as an association taxable as a corporation effective Date 3.

                              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
one class of stock.

   Section 1361(b)(3)(A) provides that, except as provided in regulations prescribed

by the Secretary, for purposes of the Code-(i) a corporation which is a QSub shall not
be treated as a separate corporation, and (ii) all assets, liabilities, and items of income,
deduction, and credit of a QSub shall be treated as assets, liabilities, and such items (as
the case may be) of the S corporation.
PLR-110066-21 3

  Section 1361(b)(3)(B) provides that the term “QSub” means any domestic

corporation which is not an ineligible corporation (as defined in § 1361(b)(2)), if (i) 100
percent of the stock of such corporation is held by the S corporation, and (ii) the S
corporation elects to treat such corporation as a QSub.

    Section 1.1361-3(a)(1) of the Income Tax Regulations provides that the

corporation for which a QSub election is made must meet all the requirements of
§ 1361(b)(3)(B) at the time the election is made and for all periods for which the election
is to be effective.

   Section 1362(f) provides, in part, that if (1) an election under § 1362(a) or

§ 1361(b)(3)(B)(ii) by any corporation (A) 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 (B) was terminated under § 1362(d)(2) or (3) or
§ 1361(b)(3)(C), (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 discovery of the circumstances resulting in the 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 or a QSub, as the case may be,
and (4) the corporation for 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), agrees to make such adjustments (consistent
with the treatment of the corporation as an S corporation or a QSub, as the case may
be) as may be required by the Secretary with respect to such period, then,
notwithstanding the circumstances resulting in the ineffectiveness or termination, the
corporation will be treated as an S corporation or a QSub, as the case may be, during
the period specified by the Secretary.

                                  CONCLUSION

   Based solely on the facts submitted and the representations made, we conclude

that X’s election to treat Sub as a QSub effective Date 3 was ineffective. We also
conclude that the circumstances resulting in the ineffectiveness of the QSub election
were inadvertent within the meaning of § 1362(f). Thus, under the provisions of
§ 1362(f), Sub will be treated as a QSub effective Date 3, provided that the QSub
election was otherwise valid and not otherwise terminated under § 1361(b)(3)(C).

   This ruling is contingent on Sub filing Form 8832 electing to be an association

taxable as a corporation effective Date 3 within 120 days from the date of this letter. If
this requirement is not met, the ruling is null and void.

   Except as specifically ruled upon above, we express or imply no opinion

concerning the federal tax consequences of the facts described above under any other
provision of the Code. Specifically, we express or imply no opinion on whether Sub is
otherwise eligible to be a QSub.
PLR-110066-21 4

   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 that requested it. Section 6110(k)(3)

provides that this ruling may not be used or cited as precedent.

    Pursuant to a power of attorney on file with this office, we are sending a copy of

this letter to your authorized representatives.

                                              Sincerely,




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

Enclosure:
Copy for § 6110 purposes

cc: