Ineligible partnership shareholder caused inadvertent ineffective S election

Plain-English summary

A corporation's S election was ineffective because one shareholder was a limited partnership and therefore was not an eligible S corporation shareholder. After discovering the problem, the partnership transferred all of its shares to eligible shareholders. Based on the corporation's representations that the problem was inadvertent and not motivated by tax avoidance or retroactive tax planning, the IRS granted relief under section 1362(f) and treated the corporation as an S corporation from the intended effective date onward, assuming its election was not otherwise ineffective or terminated.

Ruling snapshot

• Question: Could a corporation receive inadvertent-election relief when its S election was ineffective because a limited partnership held shares?
• Outcome: Approved; the corporation would be treated as an S corporation from the intended effective date and thereafter, subject to the stated conditions.
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1362-4(b)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201926009                                              Third Party Communication: None
Release Date: 6/28/2019                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                               Person To Contact:
---------------------------------------------------            --------------------, ID No. ------------------
------------------------------------------------------------   Telephone Number:

-                                                              ----------------------
------------------------------                                 Refer Reply To:
----------------------------                                   CC:PSI:B03
                                                               PLR-134288-18
                                                               Date:
                                                               March 20, 2019




X                 =         ------------------------------
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State             =        --------------
D1                =        --------------------------
D2                =        ----------------------
D3                =        -------------------
D4                =        ---------------------------
Y                 =         --------------------------------
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Dear ------ --------:

        This responds to a letter dated November 19, 2018, submitted on behalf of X by
its authorized representative, requesting a ruling under § 1362(f) of the Internal
Revenue Code.

        The information submitted states that X was incorporated in State on D1, and
filed an election to be an S corporation effective D2. On D3, X learned that the Service
could not accept its S corporation election because one of its shareholders, Y, was a
limited partnership and therefore not an eligible S corporation shareholder. This
rendered X’s S corporation election ineffective. On D4, all of the shares owned by Y
were transferred to eligible S corporation shareholders.

       X represents that the circumstances resulting in X's ineffective S corporation
election were inadvertent and not motivated by tax avoidance or retroactive tax
planning. 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.
PLR-134288-18                                2


                                  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) provides that the term “small business corporation” means 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 1362(a) provides that, except as provided in § 1362(g), a small business
corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

       Section 1362(f) provides 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, (2) the Secretary determines that the
circumstances resulting in the ineffectiveness were inadvertent, (3) no later than a
reasonable period of time after discovery of the event resulting in the ineffectiveness,
steps were taken (A) so that the corporation is a small business corporation, or (B) to
acquire the required 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 such
ineffectiveness, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

        Section 1.1362-4(b) of the Income Tax Regulations provides that the
determination of whether an invalid S corporation election was inadvertent is made by
the Commissioner. The corporation has the burden of establishing that under the
relevant facts and circumstances the Commissioner should determine that the invalid
election was inadvertent. The fact that the invalidity of the election was not reasonably
within the control of the corporation or the fact that the circumstances took place without
the knowledge of the corporation, notwithstanding its due diligence to safeguard itself
against such circumstance, tends to establish the invalidity of the election was
inadvertent.
PLR-134288-18                                  3


                                       CONCLUSION

       Based solely on the facts submitted and the representations made, we conclude
that X's S corporation election was ineffective because Y was an ineligible S corporation
shareholder. We conclude, however, such ineffectiveness was inadvertent within the
meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will
be treated as an S corporation from D2 and thereafter, provided that X's election was
not otherwise ineffective or terminated under § 1361(b) or § 1362(d).

       Except as specifically ruled above, we express no opinion concerning the federal
tax consequences of any transaction described above under any other provisions of the
Code.

      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.

       Pursuant to a power of attorney on file with this office, a copy of this letter is
being forwarded to X's 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 for § 6110 purposes