Corporation retains S status after stock sale to ineligible shareholder

Plain-English summary

An S corporation's election terminated when another S corporation, which was not an eligible shareholder, acquired some of its stock. After discovering the problem, the original shareholder trusts transferred their remaining stock to the acquiring corporation, which planned to elect qualified subchapter S subsidiary treatment for the target. The taxpayer represented that the termination was inadvertent and did not involve tax avoidance or retroactive tax planning. The IRS allowed the target to be treated as continuously maintaining its S corporation status from the disqualifying acquisition until the later transfer. The ruling assumes the S election was otherwise valid and was not terminated for another reason.

Ruling snapshot

• Question: Could the corporation retain S status during the period that an ineligible corporate shareholder owned some of its stock?
• Outcome: approved, the termination was treated as inadvertent
• Key authorities: IRC §§ 1361(b)(3) and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201714015 Third Party Communication: None
Release Date: 4/7/2017 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
-------------------------- ----------------------, ID No. ----------------
------------------------------------------------------ Telephone Number:
------------------------------------------- --------------------
-------------------------- Refer Reply To:
CC:PSI:B03
PLR-121376-16
Date: January 3, 2017

                                                 LEGEND

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

State = ----------

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

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

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

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

D4 = ---------------------

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

   This letter responds to a letter dated June 27, 2016, and subsequent

correspondence submitted on behalf of X requesting a ruling under § 1362(f) of the
Internal Revenue Code (Code).

                                                 FACTS

PLR-121376-16 2

    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. Prior to D2, X’s
shareholders were trusts that X represents are eligible S corporation shareholders. On
D2, an unrelated S corporation, Y, acquired shares of stock in X. Because Y is an
ineligible S corporation shareholder, X’s S corporation election terminated on D2. In
D3, X learned that Y is not an eligible S corporation shareholder and its S corporation
election terminated on D2. On D4, the trusts transferred their X stock to Y in exchange
for Y stock. Y plans to elect under § 1361(b)(3) to treat wholly owned X as a qualified
subchapter S subsidiary (QSub) effective D4.

   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 adjustments,
consistent with the treatment of X as an S corporation, as may be required by the
Commissioner.

                              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(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.

                                 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 to D4, provided that X’s S corporation election was
otherwise valid and was not otherwise terminated under § 1362(d).

PLR-121376-16 3

   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 representative.

   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/

                                  Mary Beth Carchia
                                  Senior Technician Reviewer, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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