S status survives a possible second class of stock during entity conversions

Plain-English summary

An S corporation converted first into a limited partnership that elected corporate tax treatment and then into another corporation. The first conversion may have created a prohibited second class of stock and terminated the S election, although the taxpayer believed the election carried through because the conversions were F reorganizations. The taxpayer represented that any termination was unintended, not tax-motivated, and consistently reported S corporation treatment. The IRS granted inadvertent-termination relief and treated the taxpayer as an S corporation from the original election date until the successor was sold to an ineligible shareholder, provided no other termination occurred. The ruling did not decide whether the conversions qualified as F reorganizations or whether the taxpayer was otherwise eligible for S status.

Ruling snapshot

• Question: If entity conversions may have created a second class of stock, was the resulting S election termination inadvertent?
• Outcome: Approved, with continuous S treatment through the sale date if no other termination occurred.
• Key authorities: IRC §§ 1361, 1362(d), 1362(f), and 368(a)(1)(F)

Full text (IRS public release)

Internal Revenue Service                                         Department of the Treasury
                                                                 Washington, DC 20224

Number: 201614029                                                Third Party Communication: None
Release Date: 4/1/2016                                           Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                                 Person To Contact:
-----------------------------------                              --------------, ID No. ----------------
------------------------------------------------------           Telephone Number:
------------------------------------------------------------     --------------------
------------------------------------------------------------     Refer Reply To:
------------                                                     CC:PSI:B01
-------------------                                              PLR-136350-15
--------------------------------------                           Date:
                                                                 December 16, 2015




LEGEND

X                          =        -------------------------------------------------
                                    EIN: ----------------

Y                          =        --------------------------------------------------

Z                          =         ------------------------------------------------------
---------------------------------------------------------------------------------------------------------------
                                    ---------------------------------------------------
                           EIN: ----------------

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

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

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

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

Date 5                     =        -----------------

State 1                    =        ----------

State 2                    =        --------
PLR-136350-15                                2



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

This responds to a letter signed October 30, 2015, submitted on behalf of Z (successor
to X and Y) by Z’s authorized representative, requesting relief under section 1362(f) of
the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations made within, X was
incorporated on Date 1 under the laws of State 1. On Date 2, X made an election to be
treated as an S corporation. On Date 3, X converted to Y, a limited partnership, under
the laws of State 2, and made an election to be treated as an association taxable as a
corporation for U.S. federal income tax purposes. On Date 4, Y converted to Z, a
corporation, under the laws of State 2. On Date 5, all of the shares of Z were sold to an
unrelated third party purchaser, an ineligible S corporation shareholder. X, Y, and Z are
hereinafter collectively referred to as the taxpayer.

The conversion on Date 3 may have created a second class of stock in violation of the
one class of stock requirement under § 1361(b)(1)(D), thereby possibly causing X’s S
corporation election to terminate. Other than this potential termination of the S
corporation election, Z has qualified as an S corporation. The taxpayer represents that
the conversions on Date 3 and Date 4 qualified as F reorganizations within the meaning
of § 368(a)(1)(F). The taxpayer represents that it believed that the S corporation
election succeeded to Y and Z because the conversions were F reorganizations.

The taxpayer represents that the possible termination of its S corporation election was
inadvertent and was not motivated by tax avoidance or retroactive tax planning. The
taxpayer represents that neither it nor any of its shareholders intended to terminate the
taxpayer’s Subchapter S election. In addition, the taxpayer represents that other than
the possible inadvertent termination, the taxpayer has qualified as a small business
corporation at all times since Date 2. Further, the taxpayer represents that the taxpayer
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) of the
Code that may be required by the Secretary. The taxpayer and its shareholders
represent that they have filed all returns consistent with the taxpayer being an S
corporation.

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
PLR-136350-15                                3

domestic corporation which is not an ineligible corporation which does not (A) have
more than 100 shareholders, (B) have as a shareholder a person (other than an estate,
and a trust described in subsection (c)(2), or an organization described in subsection
(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 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 part that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d), (2) the Secretary determines that the
circumstances resulting in the termination were inadvertent, (3) no later than a
reasonable period of time after the discovery of the circumstances resulting in the
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, 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 of inadvertent 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 termination, the corporation is treated as an S corporation
during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the conversion on Date 3 may have caused the taxpayer to have more than one class of
stock. We conclude, however, that if the taxpayer’s S election was terminated, such
termination was inadvertent within the meaning the meaning of § 1362(f). Therefore,
the taxpayer will be treated as an S corporation effective Date 2 through Date 5, when Z
was sold, provided the taxpayer’s S corporation election is not otherwise terminated
under § 1362(d).

Except as specifically ruled upon 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. Specifically, we express or imply no opinion regarding the taxpayer’s eligibility to
be an S corporation. In addition, we express or imply no opinion on conversions on
Date 2 and Date 3 qualified as F reorganizations within the meaning of § 368(a)(1)(F).

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.
PLR-136350-15                                  4

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to the taxpayer’s authorized representative.

                                        Sincerely,


                                        David R. Haglund
                                        David R. Haglund
                                        Branch Chief, Branch 1
                                        Office of the Associate Chief Counsel
                                        (Passthroughs & Special Industries)



Enclosures (2)
 Copy of this letter
 Copy of this letter for section 6110 purposes


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