S corporation termination was inadvertent after stock reached an ineligible shareholder

Plain-English summary

An S corporation issued stock under an option agreement to a nonresident alien, who was not an eligible S corporation shareholder. The corporation discovered the problem later and promptly repurchased the shares. It represented that the issuance did not involve tax avoidance, retroactive tax planning, or a plan to terminate its S status, and that the affected parties would make any required adjustments. The IRS ruled that the resulting termination was inadvertent under section 1362(f). The corporation would therefore be treated as continuously maintaining S corporation status, assuming its election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Question: Was the S corporation's termination inadvertent when stock was issued to a nonresident alien and later repurchased?
• Outcome: approved
• Key authorities: IRC §§ 1361(a), 1361(b)(1), 1362(d)(2), 1362(f)

Full text (IRS public release)

Internal Revenue Service                                    Department of the Treasury
                                                            Washington, DC 20224

Number: 201748004                                           Third Party Communication: None
Release Date: 12/1/2017                                     Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                            Person To Contact:
--------------------------                                  --------------------, ID No. ------------------
---------------------------
--------------                                              Telephone Number:
----------------------------------------                    ----------------------
-------------------------------                             Refer Reply To:
                                                            CC:PSI:B03
                                                            PLR-113759-17
                                                            Date:
                                                            August 31, 2017




                                                  LEGEND

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

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

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

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

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

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

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


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

       This letter responds to a letter dated April 14, 2017, and subsequent
correspondence, submitted on behalf of X, requesting a ruling under § 1362(f) of the
Internal Revenue Code (the 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.
PLR-113759-17                                  2

       On Date 2, X stock was issued to A pursuant to a stock option agreement. A, a
nonresident alien, was an ineligible shareholder. Only subsequently in Date 3 did X
become aware of A’s ineligibility. Soon thereafter, on Date 4, X repurchased the X
stock issued to A.

        X represents the following: (1) the issuance of X stock involved no tax avoidance
or retroactive tax planning; (2) the issuance was not part of a plan to terminate X’s
S corporation status; and (3) X and its shareholders agree to make any adjustments
consistent with the treatment of X as an S corporation as may be required by the
Secretary.

                                          LAW

       Under § 1361(a)(1), an S corporation is a small business corporation for which
an election under § 1362(a) is in effect. Section 1361(b)(1) defines “small business
corporation,” in part, as a corporation that has no nonresident aliens as shareholders.

       Section 1362(d)(2) terminates a corporation’s S corporation status when the
corporation ceases to be a small business corporation. The termination is effective on
and after that date.

       Under § 1362(f), a corporation that has lost its S corporation status under
§ 1362(d)(2) will be treated as continuing to be an S corporation during the period
specified by the Secretary if: the Secretary determines that the termination was
inadvertent; the corporation took steps to return to its status as a small business
corporation within a reasonable time after the discovery of the termination; and the
corporation and all persons who were shareholders during the specified period agree to
make adjustments required by the Secretary consistent with the treatment of the
corporation as an S corporation.

                                     CONCLUSION

        Based solely on the facts submitted and the representations made, we conclude
that X's S corporation election terminated under § 1362(d)(2) on Date 2 when X stock
was issued to A who was an ineligible S Corporation stockholder due to the fact that A
was a nonresident alien. We further conclude that the termination was “inadvertent”
within the meaning of § 1362(f). Therefore, under § 1362(f) X will be treated as
continuing to be an S corporation on and after Date 2, provided X's S corporation
election was otherwise valid and not otherwise terminated under § 1362(d)(2).

       Except as specifically ruled upon above, we express or imply no opinion
concerning the federal tax consequences of the facts of this case under any other
provision of the Code. Specifically, we express or imply no opinion regarding whether X
is otherwise eligible to be an S corporation.
PLR-113759-17                                   3

      This ruling is directed only to the taxpayer who requested it. According to
§ 6110(k)(3), this ruling may not be used or cited as precedent.

       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.

        Pursuant to the power of attorney on file with this office, we are sending a copy of
this letter to your authorized representative.



                                      Sincerely,




                                      James A. Quinn
                                      Senior Counsel, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)




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