S corporation termination was inadvertent after stock passed to a partnership

Plain-English summary

An S corporation's shares were transferred to a partnership, which was not an eligible S corporation shareholder. The corporation discovered that the transfer had terminated its S election and arranged for the partnership to transfer the shares to three eligible shareholders. The IRS found the termination inadvertent because the parties did not intend it, acted within a reasonable time, consistently treated the company as an S corporation, and agreed to any required adjustments. The company will therefore be treated as continuously maintaining its S status, assuming the original election was valid and was not otherwise terminated. During the intervening period, the partnership will be treated as the shareholder, while the corporation's shareholders must report and adjust the relevant tax items under IRC §§ 1366 through 1368.

Ruling snapshot

• Question: Will the corporation's S election remain effective despite its temporary ownership by an ineligible partnership shareholder?
• Outcome: Approved as an inadvertent termination
• Key authorities: IRC §§ 1361(a), 1361(b), 1362(d), 1362(f), 1366, 1367, 1368

Full text (IRS public release)

Internal Revenue Service                                          Department of the Treasury
                                                                  Washington, DC 20224

Number: 201902010                                                 Third Party Communication: None
Release Date: 1/11/2019                                           Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.01-00
                                                                  Person To Contact:
-------------------------                                         ------------------------------,
-----------------------------------------                         ID No. ----------------
--------------------------                                        Telephone Number:
------------------------------------------                        ----------------------
                                                                  Refer Reply To:
                                                                  CC:PSI:B01
                                                                  PLR-107000-18
                                                                  Date:
                                                                  August 31, 2018


LEGEND

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

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

B                          =         -----------------------
-------------------------------------------------------------

C                          =         ------------------------
-------------------------------------------------------------

Partnership                =         ---------------------------------
------------------------------------------------------------

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

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

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

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

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

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

        This responds to a letter dated December 28, 2017, and subsequent
correspondence, submitted on behalf of X by X's authorized representative, requesting
relief under § 1362(f) of the Internal Revenue Code (the Code).


Facts

        According to the information submitted, X was formed under the laws of State on
Date 1 as a limited liability company. X elected to be treated as an S corporation
effective Date 1. On Date 2, all of the shares in X were transferred to Partnership, a
partnership for federal tax purposes. Partnership, as a partnership, was an ineligible
shareholder of an S corporation. On Date 3, X learned that the transfer of stock to
Partnership terminated X's S election. On Date 4, X and its shareholders took remedial
action by having Partnership transfer all of its shares in X to eligible S corporation
shareholders A, B, and C. After Date 4, all income and other items from the X shares
were allocated to A, B, and C. Between Date 2 and Date 4, all the partners of
Partnership were eligible shareholders of an S corporation.

       X represents that it did not intend for its S corporation election to terminate and
that the events that resulted in the termination were not motivated by tax avoidance or
retroactive tax planning. X represents that all shareholders filed their returns consistent
with X being an S corporation. Further, X and its shareholders agree to make any
adjustments required by the Secretary 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 such year.

       Section 1361(b)(1) defines a “small business corporation” as a domestic
corporation that is not an ineligible corporation and that 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 1362(d)(2)(A) provides that an election under § 1362(a) shall be
terminated whenever the corporation ceases to be a small business corporation.
PLR-107000-18                                3

       Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a)
by any corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 termination, steps were taken so that the corporation is once
more 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 pursuant to §
1362(f), agrees to make any adjustments (consistent with the treatment of the
corporation as an S corporation) as may be required by the Secretary with respect to
the period, then, notwithstanding the circumstances resulting in the termination, the
corporation will be treated as continuing to be an S corporation during the period
specified by the Secretary.

Conclusion

       Based solely on the information submitted and the representations made, we
conclude that X's S election terminated on Date 2, when all of the shares of X stock
were transferred to Partnership. We further conclude that the termination was
inadvertent within the meaning of § 1362(f).

       Accordingly, under § 1362(f), X will be treated as continuing to be an S
corporation on and after Date 2, provided that X's S corporation election was valid and
not otherwise terminated under § 1362(d). Partnership will be treated as the
shareholder of X from Date 2 until Date 4, at which point A, B, and C will be treated as
the shareholders. Accordingly, the shareholders of X must include in income their pro
rata share of the separately stated and nonseparately computed items of X as provided
in § 1366, make an adjustments to basis as provided in § 1367, and take into account
any distributions made by X as provided in § 1368.

       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 concerning whether X is
otherwise eligible to be treated as an S corporation.

      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.

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


                                          Sincerely,


                                          Laura C. Fields
                                          Laura C. Fields
                                          Senior Technician Reviewer, Branch 1
                                          Office of Associate Chief Counsel
                                          (Passthroughs & Special Industries)




Enclosures (2)

       Copy of this letter
       Copy of this letter for section 6110 purposes