S corporation preserves status after partnership became an indirect shareholder

Plain-English summary

A husband and wife owned an S corporation interest through a grantor trust and a community-property LLC treated as disregarded. The trust transferred the LLC interest to another LLC taxed as a partnership, making that partnership an ineligible indirect S corporation shareholder and terminating the corporation's S election. After discovering the problem, the corporation and its shareholders restored ownership to eligible shareholders and continued filing consistently with S treatment. The IRS found the termination inadvertent and treated the corporation as continuing to be an S corporation. Relief is conditioned on filing all required open-year returns consistently within 120 days.

Ruling snapshot

• Question: Was the S-election termination caused by an LLC taxed as a partnership becoming an indirect shareholder inadvertent?
• Outcome: Approved, with consistent-return filings required within 120 days
• Key authorities: IRC §§ 1361(b), 1362(d), 1362(f); Rev. Proc. 2002-69

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202548006
Release Date: 11/28/2025
Index Number: 1362.00-00, 1362.02-00,
1362.02-02, 1362.04-00

Third Party Communication: None
Date of Communication: Not Applicable

Person To Contact:
----------------------------, ID No. -----------------

Telephone Number:

Refer Reply To:
CC:PT&E:B03
PLR-100781-25

Date:
July 10, 2025

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LEGEND

X = -----------------------------------------------------------
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Y = -----------------------------------------------------------
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Z = -----------------------------------------------------------
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Trust = -----------------------------------------------------------
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A = -----------------------------------------------------------
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B = -----------------------------------------------------------
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State 1 = -------------

State 2 = -------------

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

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

PLR-100781-25 2

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

This letter responds to a letter dated December 11, 2024, submitted on behalf of
X by its authorized representatives, requesting a ruling under § 1362(f) of the Internal
Revenue Code (the Code).

FACTS

The information submitted states that X, a State 1 corporation, elected to be an S
corporation effective on Date 1. Prior to Date 2, Trust, a grantor trust and eligible S
corporation shareholder under § 1361(c)(2)(A)(i), owned shares of X through Y, a State
1 limited liability company. A and B, husband and wife, were the co-grantors and co-
trustees of Trust under the laws of State 2, a community property state. A and B treated
Y as a disregarded entity for federal tax purposes in accordance with the procedures of
Rev. Proc. 2002-69.

On Date 2, Trust transferred all its interest in Y to Z, a State 1 limited liability
company treated as a partnership for federal tax purposes. Because Z was an ineligible
shareholder under § 1361(b)(1)(B), X’s S corporation election terminated on Date 2
under § 1362(d)(2). After X discovered the transfer to Z and that the transfer caused its
S corporation election to terminate, X and its shareholders took remedial action to
ensure X’s shares were all owned by eligible S corporation shareholders.

X represents that the termination of its S corporation election was not motivated
by tax avoidance or retroactive tax planning. Further, X represents that X and its
shareholders continued to file its income tax returns consistent with being an S
corporation after its S corporation election terminated. Finally, X and its shareholders
have agreed to make any adjustments consistent with the treatment of X as an S
corporation as may be required by the Commissioner with respect to the period
specified by § 1362(f).

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 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 one class of stock.

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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 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. Section 1362(d)(2)(B) provides that any termination under §
1362(d)(2) is 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 (A) 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 (B) 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 discovery of the circumstances resulting in the 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, and (4) the corporation for which
the election was made or the termination occurred 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 the ineffectiveness or
termination, the corporation will be treated as an S corporation during the period
specified by the Secretary.

Rev. Proc. 2002-69, 2002-2 C.B. 831, provides guidance on the classification of
a business entity owned by a husband and wife as community property. If the husband
and wife treat a qualified entity as a disregarded entity for federal income tax purposes,
the Service will respect that treatment. If the husband and wife treat a qualified entity as
a partnership for federal income tax purposes and file the appropriate partnership
returns, the Service will respect that treatment. A change in reporting position will be
treated as a conversion of the entity. A business entity is a qualified entity if (1) it is
wholly owned by a husband and wife as community property under the laws of a state, a
foreign country, or a possession of the United States; (2) no person other than one or
both spouses would be considered an owner for federal tax purposes; and (3) the
business entity is not treated as a corporation under § 301.7701-2.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that
X's S corporation election terminated on Date 2 when Z, an ineligible S corporation
shareholder under § 1361(b)(1)(B), acquired an interest in X. However, we conclude
that the circumstances resulting in the termination of X's S corporation election were

PLR-100781-25 4

inadvertent within the meaning of § 1362(f). Accordingly, under § 1362(f), X will be
treated as continuing to be an S corporation from Date 2 and thereafter, provided X's S
corporation election was valid and has not otherwise terminated under § 1362(d).

This ruling is contingent on X and its shareholders filing, within 120 days from the
date of this letter, all required federal income tax returns (including amended returns) for
all open years consistent with the requested relief. A copy of this letter should be
attached to any such returns.

Except as specifically ruled above, we express or imply no opinion concerning
the federal tax consequences of the facts of this case under any other provisions of the
Code. Specifically, we express or imply no opinion as to whether X was or is otherwise
eligible to be an S corporation.

This ruling is directed only to the taxpayer requesting it. According to
§ 6110(k)(3) of the Code, 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.

Under a power of attorney on file with this office, we are sending a copy of this
letter to X's authorized representatives.

Sincerely,

Associate Chief Counsel
(Passthroughs, Trusts, and Estates)

By:
Brian J. Barrett
Senior Technician Reviewer, Branch 3
Office of Associate Chief Counsel
(Passthroughs, Trusts, and Estates)

Enclosure
Copy for § 6110 purposes

PLR-100781-25 5

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