S corporation received inadvertent-termination relief

Plain-English summary

An S corporation issued shares first to an LLC taxed as a corporation and later to two LLCs taxed as partnerships. Those entities were ineligible S corporation shareholders, so the stock issuances terminated the S election. The corporation represented that the issuances were not motivated by tax avoidance or retroactive planning and that all parties had filed consistently with continued S status. The IRS found the terminations inadvertent under IRC § 1362(f). It treated the company as an S corporation through its later acquisition and restructuring, provided the election was otherwise valid and the shareholders made all required income, basis, and distribution adjustments.

Ruling snapshot

• Question: Could the corporation retain S status despite issuing stock to three ineligible shareholders?
• Outcome: Approved, inadvertent-termination relief granted
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201622015                                             Third Party Communication: None
Release Date: 5/27/2016                                       Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                              Person To Contact:
--------------------------------                              ---------------------, ID No. ------------
------------------------------                                Telephone Number:
--------------------------------------------                  --------------------
---------------------------------------                       Refer Reply To:
                                                              CC:PSI:B01
                                                              PLR-129840-15
                                                              Date:
                                                              February 29, 2016




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

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

P1                            ------------------------------------------

P2                            -----------------------------------------------

State A                =      ------------

State B                       ------------

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

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

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

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

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

Date 6                 =      --------------------------
PLR-129840-15                                 2


Dear --------------

This letter responds to a letter dated October 5, 2015, and subsequent correspondence,
submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue
Code.

Facts

The information submitted states that X was formed under the laws of State on Date 1
and elected to be treated as an S corporation effective Date 2. On Date 3, X issued
shares of its stock to Y, a State B limited liability company taxable as a corporation for
federal income tax purposes. Therefore, X’s election terminated on Date 3.

On Date 4, X issued shares of its stock to P1, a limited liability company taxable as a
partnership for federal income tax purposes. Further, on Date 5, X issued shares of
stock to P2, a limited liability company taxable as a partnership for federal income tax
purposes. Therefore, X’s S corporation election would have terminated on Date 4 and
again on Date 5 (if it had not already terminated on Date 3) when X issued shares of its
stock to P1 and P2, respectively. On Date 6, X was acquired by a corporation and
restructured.

X represents that the issuance of X stock to Y, P1 and P2, ineligible shareholders, was
not motivated by tax avoidance or retroactive tax planning. Additionally, X represents
that X and its shareholders have filed their federal income tax returns consistent with
having a valid S corporation election in effect for X. 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 Secretary with respect to the period specified by § 1362(f).

Law

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)(B) provides that a “small business corporation” means a domestic
corporation that is not an ineligible corporation and that 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(d)(2) 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. A termination of an S corporation election under § 1362(d)(2) is effective
on and after the date of cessation.
PLR-129840-15                               3


Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was
terminated under § 1362(d)(2) or (3), (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 event resulting in the ineffectiveness,
steps were taken (A) so that the corporation is a small business corporation, or (B) to
acquire the required shareholder consents, 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 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, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

Section 1366(a) generally provides that in determining the tax of an S corporation
shareholder, there shall be taken into account the shareholder’s pro rata share of the
separately and nonseparately stated items of income (including tax-exempt income),
loss, deduction, and credit of the S corporation.

Section 1366(d) generally provides that the aggregate amount of losses and deductions
taken into account by an S corporation shareholder under § 1366(a) for any taxable
year shall not exceed the sum of the shareholder’s adjusted bases in the stock and
indebtedness of the corporation. Section 1366(d)(2) provides that any loss or deduction
which is disallowed under § 1366(d)(1) carries forward indefinitely to succeeding taxable
years in which the corporation is an S corporation.

Section 1366(d)(3) provides a special rule for the carryover of suspended losses if a
corporation's S election is terminated. Under § 1366(d)(3)(A), if losses have been
disallowed in the last taxable year for which a corporation is an S corporation, the
losses are “treated as incurred by the shareholder on the last day of any post-
termination transition period.” Under § 1366(d)(3)(B), the aggregate amount of losses
and deductions taken into account under § 1366(d)(3)(A) is limited to the adjusted basis
of the shareholder's stock in the corporation determined on the last day of the post-
termination transition period. Any losses and deductions in excess of a shareholder's
adjusted stock basis are permanently disallowed. Section 1.1366-2(b)(2).

Conclusion

Based solely on the information submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 3 when shares of X were transferred
to Y, an ineligible shareholder. We further conclude that the termination was
inadvertent within the meaning of § 1362(f). Moreover, had X’s S corporation election
not already terminated, it would have terminated on Date 4 and again on Date 5 when
PLR-129840-15                                  4

shares of X were transferred to P1 and P2, respectively. Similarly, these terminating
events would have been inadvertent terminations within the meaning of § 1362(f).

Accordingly, under § 1362(f), X will be treated as an S corporation from Date 3 until
Date 6, when X was restructured, provided that X’s S election was valid and was not
otherwise terminated under § 1362(d). During the period of Date 3 to Date 6, Y will be
treated as a shareholder of X; during the period of Date 4 to Date 6, P1 will be treated
as a shareholder of X; and during the period of Date 5 to Date 6, P2 will be treated as a
shareholder of X. According, Y, P1, and P2 must include in its income any distributions
received from X during the period of ownership, and must include in income its pro rata
share of the separately and nonseparately stated items of X as provided in § 1366,
make any adjustments to stock basis as provided in § 1367, and take into account any
distributions made by X as provided in § 1368.

Except for the specific ruling above, we express no opinion concerning the federal tax
consequences of the facts described above under any other provision of the Code.
Specifically, no opinion is expressed concerning whether X was otherwise eligible to be
treated as 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.

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent
to X’s authorized representative.




                                        Sincerely,


                                        Laura C. Fields
                                        Laura C. Fields
                                        Senior Technician Reviewer, Branch 1
                                        Office of the Associate Chief Counsel
                                        (Passthroughs & Special Industries)

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


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