Corporation preserves S status after issuing preferred stock

Plain-English summary

An S corporation issued preferred stock with dividend, liquidation, conversion, and voting rights different from its common stock. That issuance created a prohibited second class of stock and terminated the S election. After discovering the problem, the corporation exchanged all preferred shares for common shares, canceled the preferred stock, and amended its articles to authorize only one class. The corporation and shareholders had filed consistently with S corporation treatment and agreed to make any required adjustments. The IRS treated the termination as inadvertent and allowed S status to continue from the termination date onward.

Ruling snapshot

• Question: Was the S election's termination from issuing a second class of stock inadvertent under section 1362(f)?
• Outcome: approved, S corporation status continues after corrective action
• Key authorities: IRC §§ 1361(b)(1)(D) and 1362(d), (f)

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 201751007                                               Third Party Communication: None
Release Date: 12/22/2017                                        Date of Communication: Not Applicable
Index Number: 1361.01-04, 1362.02-02,                           Person To Contact:
              1362.04-00                                        -------------------, ID No. -------------------
                                                                -----------------------------------------------
                                                                Telephone Number:
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                                                                Refer Reply To:
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                                                                PLR-110655-17
                                                                Date:
                                                                              September 20, 2017



LEGEND

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

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

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

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

Date 5                     =        --------------------

Year                       =        -------

Shareholder 1              =         ---------------------------
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Shareholder 2              =         ------------------
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Shareholder 3              =         ----------------------------
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Shareholder 4              =         ---------------------
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State                      =        --------------
PLR-110655-17                                2


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

This responds to a letter dated March 27, 2017, and subsequent correspondence,
submitted on behalf of X, by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations made within, X was formed
and made a timely S corporation election effective Date 1, under the laws of State.

On Date 1, X’s Articles of Incorporation authorized the issuance of common stock. On
Date 1, X issued shares of common stock equally to two shareholders, Shareholder 1
and Shareholder 2.

On Date 2, X amended and restated its Articles of Incorporation to authorize the
issuance of shares of preferred stock. The preferred stock provided for different rights
with regard to dividends, preference in liquidation proceeds, certain conversion rights,
and voting rights. On Date 2, X entered into a Stock Purchase Agreement with
Shareholder 3 and Shareholder 3 purchased shares of the preferred stock. On Date 3,
X entered into a Stock Purchase Agreement with Shareholder 4 and Shareholder 4
purchased shares of the preferred stock. On Date 4, X again amended and restated its
Articles of Incorporation to authorize the issuance of additional shares of preferred stock
and Shareholder 4 purchased additional shares of the preferred stock.

The issuance of the preferred stock on Date 2 created a second class of stock within
the meaning of § 1361(b)(1)(D), causing X’s S election to terminate effective Date 2.
X’s S election would have also terminated on Date 3 and Date 4 had it not already
previously terminated.

X represents that in Year it became aware that the issuance of the preferred stock may
have inadvertently terminated its S corporation election. X represents that on Date 5 it
took corrective action and (1) entered into agreements with Shareholder 3 and
Shareholder 4 to exchange their preferred stock for common stock; and (2) amended
and restated its Articles of Incorporation to authorize only a single class of stock. X
represents that as of Date 5 all issued and outstanding shares of preferred stock have
been cancelled and retired. X also represents that its shareholders have taken into
account their pro rate shares of X’s separately and non-separately computed items
pursuant to § 1366 and have made any adjustments to stock basis as required under
§ 1367. Furthermore, X represents that its shareholders have accounted for any
distributions made under § 1368.
PLR-110655-17                                3

X represents that the termination of its S corporation election was inadvertent and was
not motivated by tax avoidance or retroactive tax planning. X represents that X and its
shareholders filed returns consistent with X’s status as an S corporation. Further, X
represents that X and its shareholders agree to make any adjustments required as a
condition of obtaining relief under the inadvertent termination rule as provided under
§ 1362(f) of the Code that may be required by the Secretary.

LAW AND ANALYSIS

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 the year. Section 1361(b)(1) defines a “small business corporation” as a
domestic corporation which is not an ineligible corporation and which does not (A) have
more than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more
than 1 class of stock.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the taxable year for which the
corporation is an S corporation) such corporation ceases to be a small business
corporation.

Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d), (2) the Secretary determines that the
circumstances resulting in the termination were inadvertent, (3) no later than a
reasonable period of time after the discovery of the circumstances resulting in the
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, and (4) the corporation for which the termination
occurred, and each person who was a shareholder in such corporation at any time
during the period of inadvertent termination of the S election, 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 termination, the corporation is treated as an S corporation
during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the circumstances represented by the taxpayer have caused an inadvertent termination
of X’s S corporation election within the meaning of § 1362(f). Therefore, X will be
treated as an S corporation effective Date 2 and thereafter, provided X’s S corporation
election is not otherwise terminated under § 1362(d).
PLR-110655-17                                  4

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 X’s eligibility to be an S
corporation.

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.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to the taxpayer’s authorized representative.

                                        Sincerely,

                                        Joy C. Spies

                                        Joy C. Spies
                                        Senior Technician Reviewer, Branch 1
                                        Office of the Associate Chief Counsel
                                        (Passthroughs & Special Industries)



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


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