Partnership ownership caused inadvertent S corporation termination

Plain-English summary

An S corporation's initial shareholders transferred their stock to a partnership they wholly owned, causing the S election to terminate because the partnership was not an eligible shareholder. After discovering the problem, the shareholders reacquired the remaining stock, and the corporation and shareholders agreed to any required adjustments. The IRS ruled that the termination was inadvertent and treated the corporation as continuing its S status. During the affected period, the partnership's owners were treated as owning the corporation's stock in proportion to their partnership interests.

Ruling snapshot

• Question: Was the S corporation election's termination caused by partnership ownership inadvertent under section 1362(f)?
• Outcome: approved
• Key authorities: IRC §§ 1361(b), 1362(a), 1362(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201652015 Third Party Communication: None
Release Date: 12/23/2016 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
---------------------------- ---------------------, ID No. -----------------
-------------------------- Telephone Number:
--------------- --------------------
------------------------------ Refer Reply To:
CC:PSI:B03
PLR-118962-16
Date:
September 21, 2016

                                                LEGEND

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

State = -------

Partnership = -------------------------------

D1 = ------------------------

D2 = ---------------------

D3 = --------------------

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

   This letter responds to a letter received April 13, 2016, and subsequent

correspondence, submitted on behalf of X requesting a ruling under § 1362(f) of the
Internal Revenue Code (Code).
PLR-118962-16 2

                                      FACTS

     The information submitted states that X was formed under the laws of State and

elected to be treated as a subchapter S corporation effective D1. On D2, X’s initial
shareholders transferred their X stock to Partnership (which was wholly-owned by X’s
initial shareholders), thus terminating X’s S corporation election. Partnership
subsequently transferred some of the X stock to a new eligible shareholder and some
back to one of the initial shareholders. On D3, after discovering the termination of X’s S
corporation election, the initial shareholders reacquired the remaining X stock held by
Partnership.

   X represents that 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 Service.

                              LAW AND ANALYSIS

  Section 1362(a) provides that 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 shall be
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 (A) so that the corporation is a small business corporation or (B) to
acquire the 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 the ineffectiveness or
termination, the corporation will be treated as an S corporation during the period
specified by the Secretary.
PLR-118962-16 3

                                  CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

the termination of X’s S corporation election on D2, was inadvertent within the meaning
of § 1362(f). Pursuant to the provisions of § 1362(f), X will be treated as continuing to
be an S corporation from D2, and thereafter, provided that X’s S corporation election
was otherwise valid and was not otherwise terminated under § 1362(d). Moreover, from
D2 through D3, Partnership’s owners shall be treated as the owners of X stock held by
Partnership during this period in proportion to their interests in Partnership.

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the transactions described above under any other
provisions of the Code. Specifically, we express or imply no opinion regarding whether
X is otherwise eligible to be treated as an S corporation.

   This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

of the Code provides that it may not be used or cited as precedent.

    Pursuant to a power of attorney on file with this office, we are sending a copy of

this letter to X’s authorized representatives.

   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.

                                  Sincerely,

                                  /s/

                                  Bradford R. Poston
                                  Senior Counsel, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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