S corporation status restored after stock accidentally went to an ineligible IRA shareholder

Plain-English summary

An S corporation is a small business corporation that passes its income
through to its shareholders, but only certain shareholders are allowed;
an individual retirement account (IRA) is not an eligible shareholder.
Here the company issued shares to an IRA custodian, which automatically
terminated its S corporation election on that date. When the company
learned of the problem, it redeemed all of the IRA's stock. It then asked
the IRS for relief under Section 1362(f), which lets the IRS forgive an
"inadvertent" termination if the company fixes the problem within a
reasonable time and everyone agrees to make consistent tax adjustments.
The IRS found the termination was inadvertent and not tax-motivated, so
it ruled the company will be treated as continuing to be an S corporation
without interruption. Relief is conditioned on the affected shareholder
filing any needed returns within 120 days and the company sending a
specified payment within 45 days. This keeps the company and its owners
from losing pass-through tax treatment over an accidental slip.

Ruling snapshot

• Question: Was the termination of the company's S corporation election (caused by issuing stock to an ineligible IRA shareholder) inadvertent, so it can keep S status?
• Outcome: Approved (inadvertent-termination relief granted under § 1362(f), subject to conditions)
• Key authorities: IRC §§ 1361(b)(1), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(e)(1)

Full text (IRS public release)

 Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202246001                                            Third Party Communication: None
 Release Date: 11/18/2022                                     Date of Communication: Not Applicable
 Index Number: 1362.01-00, 1362.04-00
                                                              Person To Contact:
 --------------------------------------                       ----------------------, ID No. -----------------
 ---------------------------                                  Telephone Number:
 -------------------------------------                        --------------------
 ------------------------------------------------             Refer Reply To:
 ----------------------------                                 CC:PSI:B01
                                                              PLR-103426-22
                                                              Date:
                                                              August 10, 2022




                                                      LEGEND

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

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

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

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

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

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

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

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

 o              =       ---------------


Dear -------------------:
PLR-103426-22                                 2

This letter responds to a letter dated February 8, 2022, and supplemental information
submitted on behalf of X by its authorized representatives, requesting relief under §
1362(f) of the Internal Revenue Code (Code).

                                          FACTS

According to the information submitted, X is a corporation organized under the laws of
State on Date 1. X filed an election to be treated as an S corporation pursuant to IRC
Section 1362(a), to be effective Date 2.

On Date 3, X issued shares of X to LLC, a custodian for A's individual retirement
account (IRA). Because A's IRA is an ineligible shareholder under § 1361(b)(1), X's S
corporation election terminated on Date 3. On Date 4, upon learning of the termination
of its S corporation status, X redeemed all of the X stock owned by A's IRA.

X represents that it has filed tax returns consistent with being an S corporation since
Date 2. X further represents that the circumstances resulting in the termination of its S
corporation election were inadvertent and were not motivated by tax avoidance or tax
planning. X and its shareholders have agreed to make adjustments consistent with the
treatment of X as an S corporation, 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 such year. Section 1361(b)(1) provides that the term "small business
corporation" means 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 1.1361-1(e)(1) provides that the person for whom stock of a corporation is held
by a nominee, guardian, custodian, or an agent is considered to be the shareholder of
the corporation. For example, a partnership may be a nominee of S corporation stock
for a person who qualifies as a shareholder of an S corporation. However, if the
partnership is the beneficial owner of the stock, then the partnership is the shareholder,
and the corporation does not qualify as a small business corporation.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be 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.
PLR-103426-22                                  3

Section 1362(f) provides, in relevant part, that if (1) an election under § 1361(b)(3)(B)(ii)
by any corporation 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 to obtain shareholder consents or was terminated under § 1362(d)(2) or (3)
or § 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 so that the corporation for which the election was made or
the termination occurred is a small business corporation or 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 § 1362(f), agrees to make the
adjustments (consistent with the treatment of such corporation as an S corporation) 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 during the period specified by the Secretary.

                                      CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X's S
election terminated on Date 3, when A's IRA became a shareholder of X. 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 from
Date 3, and thereafter, provided that X's S corporation election was valid and was not
otherwise terminated under § 1362(d).

As a condition to the relief provided herein, A must file within 120 days of this letter any
necessary original and amended tax returns for all open years, taking into account A's
share of the separately stated and nonseparately stated items of income, loss,
deduction, or credit as provided in § 1366 and consistent with the relief granted in the
letter. Furthermore, as an adjustment under § 1362(f)(4), a payment of $o and a copy of
this letter must be sent to the following address within 45 days from the date of this
letter: Internal Revenue Service, Kansas City Service Center, 333 W. Pershing Road,
Kansas City, MO 64108, Stop 7777, Attn: Manual Deposit.

If the above conditions are not met, then this ruling is null and void. Furthermore, if
these conditions are not met, X must notify the service center with which it filed its S
corporation election that its election terminated on Date 3.

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. Specifically, no opinion is expressed or implied concerning the eligibility of X
to be an S corporation.
PLR-103426-22                                   4

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3),
this ruling 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.

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/
                                   Laura C. Fields
                                   Chief, Branch 1
                                   (Passthroughs & Special Industries)



Enclosure
Copy for § 6110 purposes