S corporation receives relief for an ineligible shareholder

Plain-English summary

Three individuals held an S corporation through separate single-member LLCs that were disregarded for federal tax purposes. On professional advice, one owner elected to treat his LLC as an S corporation, without realizing that the election made the LLC an ineligible shareholder and terminated the operating company's S election. The company and its shareholders did not intend the termination, continued filing consistently with S status, and agreed to make any required adjustments. The IRS treated the termination as inadvertent under section 1362(f) and allowed the company to remain an S corporation from the accidental termination date until its later sale to another ineligible shareholder. The ruling did not decide whether the original S election was valid or whether another event had terminated it.

Ruling snapshot

• Question: Could the company preserve S corporation status after an owner's LLC election made that LLC an ineligible shareholder?
• Outcome: approved
• Key authorities: IRC §§ 1361 and 1362(f)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201727001                                              Third Party Communication: None
Release Date: 7/7/2017                                         Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
                                                               Person To Contact:
---------------------------------------                        -------------------------, ID No. -----------------
------------------------                                       -----------------------------------------------------
--------------                                                 Telephone Number:
------------------------------------                           ----------------------
-----------------------------------------------                Refer Reply To:
                                                               CC:PSI:B03
                                                               PLR-102630-17
                                                               Date:
                                                               April 10, 2017


LEGEND

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

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

M                 =        ----------------

N                 =        -----------------

O                 =        ------------------------------------------------

A                 =        ------------------------

B                 =        --------------------------

C                 =        -------------------------------

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

Year              =        -------

Date1             =        ----------------------

Date2             =        ------------------------

Date3             =        ----------------------

Date4             =        ---------------------------
PLR-102630-17                               2




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

       This responds to a letter dated January 10, 2017, and subsequent
correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under §1362(f) of the Internal Revenue Code (the Code).

       The information submitted states that X was incorporated under the laws of State
on Date1. X also elected to be an S corporation effective Date1. Initially, all of the
shares of X were owned in equal proportion by A, B, and C. On Date2, A, B and C each
transferred all of their ownership interests in X to M, N, and O, respectively. M, N, and
O were single-member limited liability companies (LLCs) formed under the laws of State
whose interests were entirely owned by A, B, and C, respectively. M, N, and O were
disregarded as entities separate from their owners for U.S. federal income tax
purposes.

       In Year, following the advice of a tax professional, C made an election to treat O
as an S corporation effective Date3. At the time of this election, C and his tax advisor
were unaware that such election would terminate the S election of X. X represents that
X and its shareholders were unaware that C had made the S election on behalf of O
and that X’s S election had terminated on Date3 as a result. X further represents that X
and its shareholders did not intend to terminate X’s S election on Date3. On Date4, all
of the ownership interests in X were sold to Y, an ineligible S corporation shareholder.

        X represents that X and all of X’s shareholders have filed tax returns consistent
with X being an S corporation since Date1. X further 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 Secretary.

       Section 1362(f) provides that if (1) an election under § 1362(a) by a 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,
PLR-102630-17                                3

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.

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date3 as the result of O becoming an
ineligible S corporation shareholder on that date while owning X stock. We further
conclude that the termination of X’s S corporation election on Date3 was inadvertent
within the meaning of § 1362(f). We further hold that, pursuant to the provisions of
§ 1362(f), X will be treated as continuing to be an S corporation from Date3 and
thereafter, until Date4, provided that X’s S corporation election was valid and provided
that the election was not otherwise terminated under § 1362(d).

       Except as specifically set forth above, no opinion is expressed concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed regarding X’s eligibility to be an S
corporation or the validity of its S corporation election.

       This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
of the Code provides that it may not be used or cited as precedent.

      The rulings contained in this letter are 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 request for rulings, it is subject to verification on
examination.

      In accordance with the power of attorney on file with this office, we are sending
copies of this letter to X’s authorized representatives.

                                      Sincerely,



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

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


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