S corporation termination treated as inadvertent

Plain-English summary

An S corporation converted into a limited partnership and admitted a limited liability company as a shareholder. That shareholder was ineligible under the S corporation rules, and the conversion also may have created a prohibited second class of stock. After discovering the problems, an eligible shareholder acquired the ineligible holder's shares and the entity converted into a limited liability company. The IRS ruled that both the actual shareholder-based termination and any possible second-class-of-stock termination were inadvertent under section 1362(f). The entity would continue to be treated as an S corporation if its original election was valid, no other termination occurred, and it filed Form 8832 within 120 days.

Ruling snapshot

• Question: Could the entity retain S corporation treatment after an ineligible shareholder and a possible second class of stock terminated its election?
• Outcome: Approved, subject to the ruling's conditions.
• Key authorities: IRC §§ 1361 and 1362.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201643002 Third Party Communication: None
Release Date: 10/21/2016 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------- -----------------------, ID No. --------------
---------------------------- Telephone Number:
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------------------------------ Refer Reply To:
CC:PSI:B01
PLR-100932-16
Date:
July 21, 2016

X = -----------------------------------------------------------------------------------------------------
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Y = -----------------------------------------------------------------------------------------------------
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A = -----------------------------------------------------------------------------------------------------
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B = -----------------------------------------------------------------------------------------------------
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C = -----------------------------------------------------------------------------------------------------
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State = ---------

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

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

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

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

Dear ---------------
PLR-100932-16 2

This letter responds to a letter dated December 17, 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 incorporated under the laws of State on
Date 1 and elected to be treated as an S corporation effective Date 1. On Date 2, X
converted from a State corporation to a State limited partnership and X filed a new
election to be treated as an S corporation. Y was formed as a State limited liability
company to act as the general partner in the limited partnership and was wholly owned
by individuals A and B. Y became a shareholder of X on Date 2. However, Y was an
ineligible S corporation shareholder and therefore X’s S election terminated on Date 2.
Effective Date 3, C, an eligible shareholder of X, acquired Y’s shares of X stock.

The conversion on Date 2 may have created a second class of stock in violation of the
one class of stock requirement under § 1361(b)(1)(D), thereby possibly creating a
second basis for X’s S election to terminate. Therefore, X converted from a State
limited partnership to a State limited liability company on Date 4.

X represents that the termination of its S corporation election was inadvertent and 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 1361(b)(1)(D) provides that, for purposes of subchapter S, the term “small
business corporation” means a domestic corporation that does not have more than one
class of stock.

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
PLR-100932-16 3

corporation. A termination of an S corporation election under § 1362(d)(2) is effective
on and after the date of cessation.

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 circumstances resulting in the
termination, steps were taken so that the corporation is a small business corporation;
and (4) the corporation, and each person who was a shareholder of the corporation at
any time during the period specified under § 1362(f), agrees to make the adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary for that period, then, notwithstanding the circumstances
resulting in such 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 terminated on Date 2 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, we conclude that if X’s
conversion from a State corporation to a State limited partnership did create a second
class of stock, the consequent termination of X’s S corporation election was inadvertent
within the meaning of 1362(f).

Accordingly, under § 1362(f), X will be treated as an S corporation from Date 2 and
thereafter, provided X’s S corporation election was valid and provided that the election
was not otherwise terminated under § 1361(d). This ruling is conditioned upon X filing a
Form 8832 within 120 days from the date of this letter with the appropriate service
center, with a copy of this letter attached. A copy is enclosed for that purpose.

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.
PLR-100932-16 4

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