IRS forgives a botched S corporation election as inadvertent

Plain-English summary

A corporation elected to be taxed as an S corporation, but the election was ineffective because it did not collect all the required shareholder consents. The corporation had also acquired three subsidiaries and elected to treat them as qualified subchapter S subsidiaries (QSubs), and it had made a fiscal-year election on Form 8716. Because the flawed S election put all of that in doubt, the corporation asked for relief under Section 1362(f), which lets the IRS overlook an inadvertent invalid or terminated S election. The corporation represented that the defect was inadvertent and not tax-motivated, that it otherwise qualified as a small business corporation, and that it and its shareholders had filed consistently as an S corporation. The IRS agreed the failure was inadvertent and ruled that the corporation will be treated as an S corporation from the original effective date, the three subsidiaries as QSubs from the acquisition date, and the Form 8716 fiscal-year election as effective, provided each election was otherwise valid. As a condition, any shareholder who never signed the original Form 2553 must file a written consent within 120 days. The ruling was signed by the Office of Associate Chief Counsel (Passthroughs & Special Industries).

Ruling snapshot

• Question: Will the IRS treat a corporation as an S corporation despite an invalid election caused by missing shareholder consents?
• Outcome: Approved (inadvertent-ineffective-election relief under § 1362(f); S status and QSub elections preserved).
• Key authorities: IRC §§ 1361, 1362(a), 1362(d)(2), 1362(f); Treas. Reg. § 1.1362-6.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202304004 Third Party Communication: None
Release Date: 1/27/2023 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.01-00,
1362.01-01, 1362.02-00, Person To Contact:
1362.04-00 --------------------------, ID No. ---------------
Telephone Number:
----------------------------------- --------------------
------------------------------------------------ Refer Reply To:
------------------------------------------- CC:PSI:B01
---------------------- PLR-108949-22
------------------------------ Date:
October 28, 2022

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

S1 = ---------------------------------------------

S2 = ------------------------------------

S3 = --------------------------------------------------

State = ---------

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

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

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

This responds to a letter dated April 27, 2022, 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
corporation on Date 1, under the laws of State. Effective Date 1, 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. Additionally, X filed a Form 8716,
Election to Have a Tax Year Other Than a Required Tax Year, effective Date 1.

Furthermore, on Date 2, X acquired S1, S2, and S3. X filed three separate Forms 8869,
Qualified Subchapter S Subsidiary (“QSub”) Election, electing to treat S1, S2, and S3 as
QSubs effective Date 2.

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 X and its shareholders
have filed consistently with being an S corporation. X and its shareholders have also
filed consistently with S1, S2, and S3’s intended treatment as QSubs. In addition, X
represents that, other than the termination due to 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
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). Therefore, X will
be treated as an S corporation effective Date 1 and thereafter, provided X's S
corporation election was otherwise valid and is not otherwise terminated under
§ 1362(d). As X will be treated as an S corporation as of Date 2, we conclude that S1,
S2, and S3 will be treated as QSubs effective Date 2 and thereafter, provided their
QSub elections were otherwise valid and are not otherwise terminated under §
1362(b)(3)(C). Lastly, we conclude that X’s Form 8716 will be treated as effective Date
1, provided the election was otherwise valid.

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 1. 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
                                  Office of the Associate Chief Counsel
                                  (Passthroughs and Special Industries)

Enclosure:
Copy of this letter for § 6110 purposes

cc: