Disregarded entity relief preserved a subsidiary's S corporation status

Plain-English summary

An individual placed an interest in an S corporation into a wholly owned limited liability company. On an accountant's advice, that LLC then elected S corporation treatment, making it a corporation and therefore an ineligible shareholder of the first S corporation. The IRS granted the LLC 120 days to file Form 8832 electing disregarded entity status retroactive to the problematic date, which would make its S election ineffective. The IRS also treated the first corporation's resulting S election termination as inadvertent and allowed its S status to continue. The relief was void unless the LLC completed the late disregarded entity election.

Ruling snapshot

• Question: Could a late disregarded entity election undo an LLC's mistaken S election and preserve another corporation's S status?
• Outcome: Approved, conditioned on filing Form 8832 within 120 days.
• Key authorities: IRC §§ 1361, 1362(f), 7701; Treas. Reg. §§ 301.7701-2, 301.7701-3, 301.9100-3

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201744012                                              Third Party Communication: None
Release Date: 11/3/2017                                        Date of Communication: Not Applicable
Index Number: 7701.00-00, 9100.31-00
                                                               Person To Contact:
-----------------------                                        -------------------------, ID No. -----------------
------------------------------                                 -----------------------------------------------------
----------------------------                                   Telephone Number:
--------------------------------                               ----------------------
                                                               Refer Reply To:
         -----------------------------------------------       CC:PSI:B03
         ------------------------                              PLR-112242-17
         ----------------------------                          Date:
                                                               July 31, 2017



Legend

X        =        ----------------------------
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Y        =         -----------------------------------------------------
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A        =         ------------------------------
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B        =        --------------------

State1 =          -------

State2 =          -----------

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

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

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

Date4 =           ----------------------


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

      This responds to a letter dated April 10, 2017, and subsequent correspondence
submitted on behalf of X and Y, requesting that the Service grant X an extension of time
PLR-112242-17                                 2

under § 301.9100-3 of the Procedure and Administration Regulations to file an entity
classification election, and requesting that the Service grant relief to Y under § 1362(f)
of the Internal Revenue Code (“Code”).

       The information submitted states that X was formed as a limited liability company
under the laws of State1 on or about Date1. X has been wholly owned by A since its
date of formation, and therefore X is eligible to be treated as disregarded as an entity
separate from its owner for federal tax purposes.

         The information submitted further states that Y had been formed as a limited
liability company under the laws of State2 on Date2 and was reconstituted as a limited
liability company under the laws of State1 on Date3. At the time of its formation, Y had
two individuals as members, A and B. Y filed an election to be treated as an S
corporation beginning on Date2.

        Based on advice from A’s accountant, A transferred A’s interests in Y to X after
X’s formation on Date1. In addition, based on the advice of A’s accountant, X filed an
election to be treated as an S corporation effective Date4. However, A’s accountant
failed to advise A, X or Y that the S corporation election by X (which is also a deemed
entity classification election to treat X as an association taxable as a corporation for
federal tax purposes) would cause the S corporation election of Y to terminate, since X
would be an ineligible S corporation shareholder.

       The information submitted further states that Y and Y’s shareholders (including A
indirectly through X) have filed tax returns consistent with Y being an S corporation
since Date4. Y further represents that the circumstances resulting in the termination of
Y’s S corporation election were inadvertent and were not motivated by tax avoidance or
retroactive tax planning. Y and each person who was or is a shareholder of Y (including
A indirectly through X) at any time since Date4 agree to make any adjustments
(consistent with the treatment of Y as an S corporation) as may be required by the
Secretary with respect to such period.

      Section 301.7701-2(a) generally provides that a business entity is any entity
recognized for federal tax purposes that is not properly classified as a trust under
§ 301.7701-4 or otherwise subject to special treatment under the Internal Revenue
Code.

        Section 301.7701-3(a) provides that an eligible entity with at least two members
may elect to be classified as either an association (and thus a corporation under
§ 301.7701-2(b)(2)) or as a partnership, and an eligible entity with a single owner can
elect to be classified as an association or to be disregarded as an entity separate from
its owner.
PLR-112242-17                                 3

        Section 301.7701-3(a) further provides that so long as a business entity is not
classified as a corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an
eligible entity), it may elect its classification for federal tax purposes.

       Section 301.7701-3(c) provides that an entity classification election must be filed
on Form 8832 and can be effective up to seventy-five (75) days prior to the date the
form is filed or up to twelve (12) months after the date on which the form is filed.

       Section 301.9100-1(c) provides that the Commissioner may grant a reasonable
extension of time to make a regulatory election, or a statutory election (but no more than
6 months except in the case of a taxpayer who is abroad), under all subtitles of the
Internal Revenue Code except subtitles E, G, H, and I. Section 301.9100-1(b) defines
the term “regulatory election” as an election whose due date is prescribed by a
regulation published in the Federal Register or a revenue ruling, revenue procedure,
notice, or announcement published in the Internal Revenue Bulletin.

        Sections 301.9100-1 through 301.9100-3 provide the standards the
Commissioner will use to determine whether to grant an extension of time to make the
election. Section 301.9100-2 provides the rules governing automatic extensions of time
for making certain elections. Section 301.9100-3 provides the standards the
Commissioner will use to determine whether to grant an extension of time for regulatory
elections that do not meet the requirements of § 301.9100-2. Under § 301.9100-3, a
request for relief will be granted when the taxpayer provides evidence to establish to the
satisfaction of the Commissioner that (1) the taxpayer acted reasonably and in good
faith, and (2) granting relief will not prejudice the interests of the government.

        Section 1361(a)(1) provides that the term “S corporation” means, with respect to
any taxable year, a small business corporation for which an election under § 1362(a) is
in effect for such 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(a)(1) provides that, except as provided in § 1362(g), a small
business corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

       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 the
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 or after the date of cessation.
PLR-112242-17                                 4

        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.

        Based solely on the information submitted and the representations made, we
conclude that the requirements of § 301.9100-3 have been satisfied. As a result, X is
granted an extension of time of 120 days from the date of this letter to file a Form 8832
with the appropriate service center to elect to be treated as a disregarded entity
effective Date4. A consequence of this late election will be to render the S corporation
election of X previously made to be effective on Date4 ineffective, because X will not
have satisfied the requirements to be an S corporation as of that date. A copy of this
letter should be attached to the Form 8832.

        In addition, based solely on the facts submitted and the representations made,
we conclude that Y’s S corporation election terminated on Date4 due to X’s election to
be an S corporation effective on that date. We conclude that this termination was
inadvertent within the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), Y
will be treated as continuing to be an S corporation on Date4 and thereafter, unless Y’s
S corporation election otherwise terminated under § 1362(d) for reasons not stated in
this letter.

       This ruling is contingent upon X filing a late entity classification election to be
treated as a disregarded entity effective on Date4, as provided above. If this condition
is not met, then this letter ruling is null and void. Furthermore, if this condition is not
met, Y must send a notification that its S election has terminated to the service center
with which Y’s S election was filed.

                Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed or implied regarding Y’s
eligibility to be an S corporation or the validity of its S corporation election.

      The rulings contained in this letter are based upon information and
representations submitted by the taxpayers and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
PLR-112242-17                                  5

material submitted in support of the request for a ruling, it is subject to verification on
examination.

      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 powers of attorney on file with this office, we are sending copies of
this letter to X’s and Y’s authorized representatives.


                                                   Sincerely,


                                                   Associate Chief Counsel
                                                   (Passthroughs & Special Industries)


                                               By: ______________________________
                                                   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