S corporation keeps its status after shares briefly passed through a partnership

Plain-English summary

An S corporation can only be owned by eligible shareholders, and a partnership is not one of them. Here, shares of the S corporation were sold to an LLC that is treated as a partnership for tax purposes, which momentarily made the company ineligible and automatically terminated its S election. Immediately after the purchase, the LLC distributed all those shares to its two individual partners, who are eligible S-corporation shareholders. The company said the lapse was inadvertent and not tax-motivated, and everyone had kept filing consistently as an S corporation. It asked the IRS for inadvertent-termination relief under § 1362(f). The IRS agreed and ruled the company will be treated as continuing to be an S corporation from the date of the lapse forward, as long as its S election was otherwise valid and the shareholders make any adjustments the IRS requires.

Ruling snapshot

• Question: Was the termination of the company's S election, caused by shares briefly held by a partnership, inadvertent under § 1362(f)?
• Outcome: Approved (termination ruled inadvertent; S status preserved from the date of lapse).
• Key authorities: IRC §§ 1361, 1362(d)(2), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202317002 Third Party Communication: None
Release Date: 4/28/2023 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------------------- --------------, ID No. -----------------
------------------------------ Telephone Number:
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----------------------------- Refer Reply To:
------------------------- CC:PSI:B01
PLR-103966-22
Date:
February 02, 2023

Legend

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

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

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

                         ---------------------

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

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

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

State = ---------

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

This letter responds to a letter dated December 20, 2021, and supplemental
information, submitted on behalf of X by X's authorized representative, requesting
inadvertent termination relief under § 1362(f) of the Internal Revenue Code (Code).

                                                   Facts

The information submitted states that X was formed under the laws of State on Date 1
PLR-103966-22 2

and elected to be treated as an S corporation effective Date 2.

On Date 3, shares of X stock were sold to LLC, a partnership for federal tax purposes.
LLC, as a partnership, was an ineligible shareholder of an S corporation. Immediately
after the purchase of shares of X stock, LLC distributed all of its shares of X stock to A
and B, partners of LLC who were both individuals. X represents that both A and B are
eligible S corporation shareholders.

X represents that the circumstances resulting in the termination of X's S corporation
election were inadvertent and not motivated by tax avoidance or retroactive tax planning
considerations. X further represents that since Date 3, X has filed all returns consistent
with X's status as an S corporation and its shareholders have filed consistent with X's
status an S corporation. Additionally, X and its shareholders have agreed to make any
adjustments required as a condition of obtaining relief under § 1362(f) that the
Commissioner may require, consistent with the treatment of X as an S corporation.

                                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 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 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(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation was terminated under paragraph (2) or (3) of § 1362(d), (2) the Secretary
determines that the circumstances resulting in such termination were inadvertent, (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
termination, steps were taken so that the corporation is once more a small business
corporation, 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 any adjustments (consistent with the treatment of the corporation as an S
corporation) as may be required by the Secretary with respect to the period, then,
notwithstanding the circumstances resulting in the termination, the corporation will be
treated as continuing to be an S corporation during the period specified by the
PLR-103966-22 3

Secretary.

                                    Conclusion

Based solely on the information submitted and the representations made, we conclude
that X's S election terminated on Date 3 when LLC became an ineligible shareholder.
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 on Date 3 and thereafter, provided that X's S corporation election was valid
and not otherwise terminated under § 1362(d).

Except as specifically ruled above, we express or imply no opinion as to the federal
income tax consequences of the facts described above under any other provision of the
Code. Specifically, we express or imply no opinion regarding X's eligibility to be 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.

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,


                                   _________________________
                                  Jennifer N. Keeney
                                  Senior Counsel, Branch 1
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

Enclosure

   Copy for § 6110 purposes

PLR-103966-22 4

cc:
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