S election survived a wrong effective date and unauthorized shares

Plain-English summary

A corporation timely filed Form 2553 but mistakenly listed an effective date before the corporation was formed. It nevertheless acted as an S corporation from its formation date. The corporation later issued shares beyond the amount then authorized under state law and did not file the required amendment until it discovered the error. Because state-law rights attached to the unauthorized shares might have differed, the issuance could have created a second class of stock and terminated the S election. The IRS ruled that the election was effective from the formation date and that any later termination was inadvertent. The corporation would continue to be treated as an S corporation, subject to the election otherwise remaining valid and to giving disproportionate and corrective distributions their proper tax effect.

Ruling snapshot

• Question: Did the mistaken Form 2553 date or issuance of unauthorized shares prevent or terminate the corporation's S status?
• Outcome: Approved: the election was effective from formation, and any termination caused by the shares was inadvertent.
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service                                          Department of the Treasury
                                                                  Washington, DC 20224

Number: 201825018                                                 Third Party Communication: None
Release Date: 6/22/2018                                           Date of Communication: Not Applicable
Index Numbers: 1361.00-00, 1361.01-00,
              1361.01-04, 1362.00-00,                             Person To Contact:
              1362.04-00                                          ------------------------, ID No. ------------------
                                                                  ----------------------------------------------------
-----------------------------------------                         Telephone Number:
---------------------------                                       ----------------------
-----------------------------------                               Refer Reply To:
--------------                                                    CC:PSI:03
---------------------------------------                           PLR-131364-17
                                                                  Date:
                                                                  March 16, 2018




Legend:

X                          =         -----------------------------------------
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Shareholder 1              =         ---------------------
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Shareholder 2              =         -------------------------
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Shareholder 3              =         --------------------------
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Shareholder 4              =         -----------------------
----------------------------------------------------------------

Shareholder 5              =         -------------------
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Shareholder 6              =         ---------------------
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Shareholder 7              =         ------------------------
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State                      =        -------

Date 1                     =        ------------------------
PLR-131364-17                                        2


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

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

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

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

Date 6                =     ----------------------

a                     =     --------

b                     =     -----

c                     =     ----



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

This letter responds to a letter dated October 11, 2017 submitted on behalf of X by its
authorized representative requesting a ruling under §1362(f) of the Internal Revenue
Code (Code).

                                             FACTS

The information submitted states that X was formed under the laws of State on Date 2
and was authorized to issue a shares of common stock. Shortly after Date 2, X issued
all of its authorized shares to Shareholders 1-6.

X timely filed Form 2553, Election by a Small Business Corporation, to make an election
to be treated as an S corporation after Date 2 but on or before the 15th day of the third
month of its first taxable year beginning on Date 2. X intended to make its S election
effective Date 2, but its Form 2553 specified a Date 1 effective date, which proceeded
X’s formation. Since Date 2 X acted as if it was an S corporation.

On Date 3, X issued b additional shares of common stock to Shareholders 1-6. On
Date 4, X, by amendment to its articles of incorporation, authorized a additional shares,
but did not file a certificate of amendment with its Secretary of State as required by law.
On Date 5, X issued c shares to Shareholder 7.

After the discovery of the errors, on Date 6, X took remedial action by filing the
certificate of amendment with its Secretary of State. The remedial action made the
PLR-131364-17                                  3

previously unauthorized shares authorized and validly issued.

X represents that its governing provisions provide for one class of stock, that all of its
authorized, issued, and outstanding shares of stock confer identical rights to distribution
and liquidation proceeds, and that it did not intend to create a second class of stock or
terminate its S election. X also represents that if its S election was terminated, such
termination was inadvertent and not motivated by tax avoidance or retroactive tax
planning. In addition, X and its shareholders agree to make any adjustments required
by the Commissioner consistent with the treatment of X as an S corporation.

                                   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 one
class of stock.

Section 1.1361-1(l)(1) of the Income Tax Regulations provides, in part, that a
corporation is generally treated as having only one class of stock if all outstanding
shares of stock of the corporation confer identical rights to distribution and liquidation
proceeds.

Section 1.1361-1(l)(2)(i) provides that the determination of whether all outstanding
shares of stock confer identical rights to distribution and liquidation proceeds is made
based on the corporate charter, articles of incorporation, bylaws, applicable state law,
and binding agreements relating to distribution and liquidation proceeds (collectively,
governing provisions). A commercial contractual agreement, such as a lease,
employment agreement, or loan agreement, is not a binding agreement relating to
distribution and liquidation proceeds and thus is not a governing provision unless a
principal purpose of the agreement is to circumvent the one class of stock requirement.
Although a corporation is not treated as having more than one class of stock so long as
the governing provisions provide for identical distribution and liquidation rights, any
distributions (including actual, constructive, or deemed distributions) that differ in timing
or amount are to be given appropriate tax effect in accordance with the facts and
circumstances.

Section 1362(d)(2)(A) provides than 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
PLR-131364-17                                 4

corporation is an S corporation) such corporation ceases to be a small business
corporation. Section 1362(d)(2)(B) further provides that the termination shall be
effective on and after the date of cessation.

Section 1362(f) provides, in relevant 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 on the facts submitted and the representations made, we conclude X’s S election
was effective Date 2. If any rights conferred by State law upon the issued but
unauthorized stock of X differed in rights to distribution and liquidation proceeds from
the issued and authorized stock, X may have had more than one class of stock upon
issuance of the unauthorized stock. Accordingly, X’s S election may have terminated.
We conclude that if such a termination occurred it was inadvertent within the meaning of
§1362(f). Thus, X will be treated as continuing to be an S corporation from Date 2 and
thereafter, provided X’s S corporation election was otherwise valid and has not
otherwise terminated under §1362(d). However, disproportionate and corrective
distributions must be given appropriate tax effect.

Except as specifically ruled upon above, we express or imply no opinion concerning the
federal tax consequences of the facts described above under any other provision of the
Code.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of the
Code provides that 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.
PLR-131364-17                                5


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


                                      Sincerely,


                                      ______________________________
                                      Bradford R. Poston
                                      Special Counsel to the Associate Chief Counsel
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)

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


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