Ineligible shareholder caused an inadvertent S election termination

Plain-English summary

An S corporation unknowingly issued shares to an ineligible shareholder, terminating its S election. After counsel identified the problem, the ineligible shareholder distributed the shares to an eligible S corporation shareholder. The corporation represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive tax planning, and that it and its shareholders would make any required adjustments. The IRS granted relief under IRC § 1362(f) and treated the corporation as continuously maintaining S status from its original effective date, provided its election was valid and was not otherwise terminated. The ruling did not independently determine whether the corporation was otherwise eligible for S status.

Ruling snapshot

• Question: Was the S election termination caused by the ineligible shareholder inadvertent?
• Outcome: Approved; the corporation is treated as an S corporation continuously, subject to the ruling’s conditions
• Key authorities: IRC §§ 1361, 1362(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202511011 Third Party Communication: None
Release Date: 3/14/2025 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
------------------------------- --------------------, ID No. -----------------
-------------------------------- Telephone Number:
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------------- Refer Reply To:
------------------------- CC:PSI:1
--------------------------- PLR-112036-24
Date:
December 13, 2024

                                                  Legend

X = ---------------------------------------------------------------------------------------
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Y = ---------------------------------------------------------------------------------------
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A = ---------------------------------------------------------------------------------------
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State = ------------

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

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

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

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

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

This responds to a letter dated June 13, 2024, and additional correspondence,
submitted on behalf of X by X' s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).
PLR-112036-24 2

                                     FACTS

The information submitted states that X was organized under the laws of State on
Date 1 and elected to be treated as an S corporation, effective Date 1. On Date 2, X
issued shares of X to Y, an ineligible shareholder, thereby terminating X's S election. X
was unaware that Y was an ineligible shareholder. On Date 3, X's counsel informed X
that Y was an ineligible shareholder of X. On Date 4, Y distributed its shares in X to A,
an eligible S corporation shareholder.

X represents that it has filed tax returns consistent with being an S corporation since
Date 1. The circumstances resulting in the termination of X's S corporation election
were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X
and its shareholders have agreed to make such adjustments (consistent with the
treatment of X as an S corporation) as may be required by the Secretary.

                              LAW AND ANALYSIS

Section 1362(a) provides that, except as provided in § 1362(g), a small business
corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which
an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1) provides that a “small business corporation” means a domestic
corporation that is not an ineligible corporation and that 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(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 a
corporation is an S corporation) such corporation ceases to be a small business
corporation. Section 1362(d)(2)(B) provides that the termination shall be effective on
and after the date of cessation.

Section 1362(f) provides, in pertinent part, that if (1) an election under § 1362(a) 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 section
1361(b), or terminated under § 1362(d)(2) or (3), (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 event resulting in the
ineffectiveness or termination, steps were taken (A) so that the corporation for which the
election was made or the termination occurred is a small business corporation, and (4)
PLR-112036-24 3

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 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 such ineffectiveness or termination, the corporation shall be
treated as an S corporation during the period specified by the Secretary.

                                 CONCLUSION

Based solely on the information submitted and the representations made, we conclude
that X's S corporation election was terminated on Date 2, under § 1362(d)(2), because
of the transfer of shares of X to Y, an ineligible shareholder. We conclude, however, that
the termination described in this paragraph was inadvertent within the meaning of
§ 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as an S
corporation from Date 1 and thereafter, provided X's S corporation election was valid
and was not otherwise terminated under § 1362(d).

Except for the specific ruling above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. In particular, we express or imply no opinion regarding X's eligibility to be an S
corporation.

The ruling contained in this letter is based on information and representations submitted
by the taxpayer and accompanied by a penalty of perjury statement executed by the
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.

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 a power of attorney on file with this office, we are sending a copy of
this letter ruling to your authorized representative.

                                  Sincerely,

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

Enclosure (1)
PLR-112036-24 4

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