IRS consents to an early S-corporation re-election after an ESOP restructuring

Plain-English summary

When a company's S-corporation election is terminated, tax law normally bars it from electing S status again for five years unless the IRS consents. Here an S corporation accidentally terminated its own election by splitting its single class of stock into two classes (Class A and Class B), which an S corporation is not allowed to have. The sole shareholder then sold his Class B stock to the company's employee stock ownership plan (ESOP), and the company redeemed and cancelled his Class A stock, leaving the ESOP as the only shareholder holding one class of stock. The company asked the IRS for permission to re-elect S status before the five-year waiting period ran. Under the regulations, consent is favored when more than half the stock is now owned by people who did not own it at termination, which was true here (the ESOP). The IRS granted consent, letting the company re-elect S status as of the requested date, on the condition that the former owner does not make a § 1042 election to defer gain on his sale of stock to the ESOP.

Ruling snapshot

• Question: Will the IRS consent under § 1362(g) to let the corporation re-elect S status before the five-year waiting period expires?
• Outcome: Approved (consent granted, conditioned on no § 1042 election by the former shareholder)
• Key authorities: IRC §§ 1362(g), 1362(d), 1042; Treas. Reg. § 1.1362-5(a)

Full text (IRS public release)

Internal Revenue Service                          Department of the Treasury
                                                  Washington, DC 20224

Number: 201845011                     Third Party Communication: None
Release Date: 11/9/2018               Date of Communication: Not Applicable
Index Numbers: 1362.00-00, 1362.01-00,
              1362.01-02              Person To Contact:
                                      ----------------------, ID No. ------------------
--------------------------------------                        Telephone Number:
---------------------------------------                       ----------------------
----------------------------------                            Refer Reply To:
------------------------------                                CC:PSI:B03
                                      PLR-104304-18
                                      Date:
                                      August 14, 2018




LEGEND

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

ESOP               = -----------------------------------------------
         -------------------------------------

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

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

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

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

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

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

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

Class A stock = --------------------

Class B stock = -----------------------------------------------

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

This letter responds to a letter dated December 21, 2017, and subsequent
correspondence submitted on behalf of X requesting a ruling under § 1362(g) of the
Internal Revenue Code (Code).

                                          FACTS

X, a State corporation, elected to be an S corporation effective Date 1. On Date 2, X
converted its existing common stock into two classes of stock: Class A stock and Class
B stock. Consequently, X's S corporation election terminated on Date 2 under
§ 1362(d) when X created a second class of stock. X's sole shareholder, A, sold all of
his Class B stock to ESOP, X's employee stock ownership plan, on Date 3. A did not
make an election under § 1042.

On Date 4, X redeemed and cancelled all of A's Class A stock. Thus, on Date 4, X had
one class of stock, the Class B stock, outstanding owned by ESOP. X is requesting
permission to reelect to be an S corporation effective Date 5, prior to the termination of
the five-year waiting period imposed by § 1362(g).

                                  LAW AND ANALYSIS

Section 1362(g) provides that if a small business corporation has made an election
under § 1362(a) and if such election has been terminated under § 1362(d), the
corporation (and any successor corporation) is not eligible to make an election under
§ 1362(a) for any taxable year before its fifth taxable year which begins after its first
taxable year for which the termination is effective, unless the Secretary consents to the
election.

Section 1.1362-5(a) of the Income Tax Regulations provides that the corporation has
the burden of establishing that under the relevant facts and circumstances, the
Commissioner should consent to a new election. The fact that more than 50 percent of
the stock in the corporation is owned by persons who did not own any stock in the
corporation on the date of the termination tends to establish that consent should be
granted. In the absence of this fact, consent ordinarily is denied unless the corporation
shows that the event causing termination was not reasonably within the control of the
corporation or shareholders having a substantial interest in the corporation and was not
part of a plan on the part of the corporation or of such shareholders to terminate the
election.

                                      CONCLUSION

Based on the information submitted and the representations made, X is granted
permission to elect to be an S corporation effective Date 5. This ruling is conditioned on
A not making an election under § 1042 concerning the sale of his stock to ESOP.

Except for the specific ruling above, no opinion is expressed or implied concerning the
federal income tax consequences of the facts of this case under any other provision of
the Code including whether X was or is a small business corporation under § 1361(b).

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 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.

In accordance with a power of attorney on file with this office, we are sending a copy of
this letter ruling to your authorized representatives.

                                             Sincerely,


                                             Mary Beth Carchia
                                             Senior Technician Reviewer, Branch 3
                                             Office of the Associate Chief Counsel
                                             (Passthroughs & Special Industries)



Enclosures: Copy of this letter
            Copy of this letter for § 6110 purposes


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