S corporation status saved after an invalid election and transfers to an ineligible shareholder are ruled inadvertent under section 1362(f)

Plain-English summary

A State LLC elected to be taxed as an S corporation but never obtained all of the shareholder consents required for a valid election, so the election was ineffective from the start. Later, interests in the company were transferred to another LLC treated as a partnership, which is an ineligible S corporation shareholder and would have terminated the S election had it been valid. Once the problem was discovered, the partnership distributed its interest back to individuals. The company asked for relief under section 1362(f), representing that the defects were inadvertent and not motivated by tax avoidance. The IRS agreed the invalid election and the would-be terminations were inadvertent, so the company is treated as an S corporation from its intended effective date forward, provided any shareholder who still has not consented signs a consent statement within 120 days and the election is not otherwise invalid.

Ruling snapshot

• Question: Were an ineffective S corporation election (missing consents) and later transfers to an ineligible shareholder inadvertent, so the company keeps S status under § 1362(f)?
• Outcome: Approved (inadvertent-defect relief granted, subject to filing the missing consents).
• Key authorities: IRC § 1362(f); IRC § 1361(b); IRC § 1362(a) and (d)(2); Treas. Reg. § 1.1362-6.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202223006 Third Party Communication: None
Release Date: 6/10/2022 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.01-01,
1362.04-00 Person To Contact:
----------------------, ID No. -----------------
--------------------------------------- Telephone Number:
----------------------------- --------------------
------------------------------------------------------ Refer Reply To:
---------------------------- CC:PSI:B01
--------------------------- PLR-118222-21
Date:
March 11, 2022

Legend

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

Y = ----------------------------------------------------------------------------------------------
---------------------------

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

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

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

C = ---------------------------

D = ----------------------------

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

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

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

Date 4 = ------------------
PLR-118222-21 2

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

This responds to a letter dated August 20, 2021, 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 as a
limited liability company on Date 1, under the laws of State. Effective Date 2, X elected
to be taxed as an S corporation. However, X did not obtain all of the shareholder
consents required by § 1.1362-6, resulting in an ineffective election.

Furthermore, on Date 3, shareholder A transferred A’s interest in X to Y, and on Date 4,
shareholder B transferred a portion of B’s interest in X to Y. Y is a limited liability
company treated as a partnership for federal tax purposes. Y is therefore an ineligible
shareholder, and as a result of the Date 3 and Date 4 transfers, X’s status as an S
corporation would have terminated had it not already been ineffective. Upon discovering
that Y was an ineligible shareholder, Y distributed its interest in X to B, C, and D.

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 or Date 4, 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
and the lack of consent of required shareholders on the original Form 2553, X has
qualified as a small business corporation at all times since its election effective 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 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
PLR-118222-21 3

individual, (C) have a nonresident alien as a shareholder, and (D) have more than 1
class of stock.

Section 1362(a)(2) provides that an election to be treated as an S corporation shall be
valid only if all persons who are shareholders in such corporation on the day on which
such election is made consent to such election.

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
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.

                                   Conclusion

Based on the facts submitted and the representations made, we first conclude that X's S
corporation election was ineffective because the required shareholder consents to the
election were not obtained. However, we also conclude that the ineffectiveness 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). We further
conclude that, if X's election had not terminated on Date 3, it would have terminated on
Date 4 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).
PLR-118222-21 4

As a condition of this ruling, any current or former shareholder of X required by §
1.1362-6 to sign X's Form 2553 that has not done so must sign a written statement as
described in § 1.1362-6(b)(1) consenting to X's S election effective Date 2. The written
statement(s) must be filed with the appropriate service center within 120 days from the
date of this letter, indicating that the statement(s) are to be associated with X's originally
filed Form 2553.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

The rulings contained in this letter are based upon information and representations
submitted by X 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 request for rulings, it is subject to verification on examination.

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

                                   Sincerely,



                                   __/s/__________________________
                                   Joy C. Spies
                                   Senior Technician Reviewer, Branch 1
                                   (Passthroughs & Special Industries)

Enclosure (1)
Copy of this letter for §6110 purposes

cc: