S corporation keeps its status after stock went to an ineligible shareholder

Plain-English summary

An S corporation can only have certain kinds of shareholders. Here, the sole shareholder transferred some shares to another party that did not qualify as an eligible S-corporation shareholder, which automatically terminated the company's S election on the date of the transfer. The company did not intend to end its S status, the transfer was not tax-motivated, and the ineligible shareholder's status was later fixed so it became eligible. Everyone had kept filing their tax returns as if the company were still an S corporation. The company asked the IRS to treat the termination as "inadvertent" under § 1362(f). The IRS agreed and ruled the company will be treated as an S corporation continuously from the date of the lapse forward, as long as its S election was otherwise valid, and the shareholders agree to any adjustments the IRS requires.

Ruling snapshot

• Question: Was the termination of the company's S election, caused by stock passing to an ineligible shareholder, 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: 202317003 Third Party Communication: None
Release Date: 4/28/2023 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
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------------------------------------------ Telephone Number:
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----------------------------- Refer Reply To:
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PLR-112247-22
Date:
February 01, 2023

LEGEND

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

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

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

State = --------

p = -----

d1 = ------------------

d2 = ----------------------

d3 = --------------------------

d4 = ------------------

d5 = --------------------------

Dear ---------------:
PLR-112247-22 2

  This letter responds to a letter, dated June 22, 2022, and subsequent

correspondence, on behalf of X from X's authorized representative, requesting
inadvertent termination relief under § 1362(f) of the Internal Revenue Code.

FACTS

   According to the information submitted, X was incorporated under the laws of

State on d1, and elected to be treated as an S corporation effective d2. On d3, A, the
then sole shareholder of X, transferred p shares of X stock to B. X represents that, from
d3, and prior to d4, B was an ineligible shareholder of X. However, X represents that,
on d4, B's status as an ineligible shareholder of X was modified, causing B to become
an eligible shareholder.

   B's status as an ineligible shareholder of X caused X's status as an S corporation

to terminate on d3. A and the fiduciaries of B did not intend to terminate X's status as
an S corporation. X represents that the transfer of shares to B was not motivated by tax
avoidance, and neither X nor its shareholders intended to obtain, nor did obtain, a tax
benefit by having B as a shareholder.

   X, A, and B each filed their United States income tax returns in a manner

consistent with the treatment of X as an S corporation. X represents that A included in
A's individual income tax returns for all relevant tax years all separately and
nonseparately computed items of income, loss, deduction, and credit of X allocable to
B. X, A, and B each agree to make any adjustments consistent with the treatment of X
as an S corporation that the Secretary may require.

  X requests a ruling that the termination of its S corporation election was

inadvertent within the meaning of §1362(f).

LAW AND ANALYSIS

    Section 1361(a) 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)(B) provides, in part, that the term "small business

corporation" means a domestic corporation which is not an ineligible corporation and
which does not 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.

  Section 1362(a) provides that, except as provided in §1362(g), a small business

corporation may elect to be an S corporation.

 Section 1362(d)(2) provides that an election under § 1362(a) shall be terminated

whenever (at any time on or after the 1st day of the 1st taxable year for which the
PLR-112247-22 3

corporation is an S corporation) such corporation ceases to be a small business
corporation, and that any termination under § 1362(d)(2) 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 terminated under § 1362(d)(2); (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 such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, or to acquire the required shareholder consents; and (4)
the corporation for which 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 such 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 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 corporation election was terminated on d3 because B was an ineligible
shareholder of X. We further conclude that the termination of X's S corporation election
constituted an inadvertent termination within the meaning of §1362(f). Under the
provisions of §1362(f), X will be treated as an S corporation from d3, and thereafter,
provided that, apart from the inadvertent termination described above, X's S corporation
election was otherwise valid and has not otherwise terminated under §1362(d).

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

the federal tax consequences of the transactions described above under any other
provision of the Code. Specifically, except as specifically ruled above, we express or
imply no opinion regarding X's eligibility to be an S corporation.
PLR-112247-22 4

  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.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

                                              Sincerely,

                                                  /s/

                                              Joy C. Spies
                                              Senior Technician Reviewer, Branch 1
                                              IRS Office of Chief Counsel
                                              (Passthroughs & Special Industries)

Enclosure (1)

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