LLC received relief for an inadvertent S corporation termination

Plain-English summary

An LLC elected to be taxed as a corporation and as an S corporation. Its original agreement required distributions in proportion to ownership, but a later amendment directed liquidating distributions according to positive capital account balances. That provision created nonidentical liquidation rights and terminated the S election by creating a second class of stock. The members later corrected the language, had always made distributions pro rata, and had consistently filed as an S corporation. The IRS found the termination inadvertent and ruled that the company would continue to be treated as an S corporation if it otherwise remained eligible.

Ruling snapshot

• Question: Could the LLC retain S corporation treatment after an amendment created unequal liquidation rights?
• Outcome: approved as an inadvertent termination
• Key authorities: IRC §§ 1361(a), 1361(b), 1362(f); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201930023                                            Third Party Communication: None
Release Date: 7/26/2019                                      Date of Communication: Not Applicable
Index Number: 1361.01-04, 1362.02-00,
              1362.04-00                                     Person To Contact:
                                                             -----------------------, ID No. -------------------
-------------------------------------                        ---------------------------------------------------
--------------------------                                   Telephone Number:
----------------------------------------                     ----------------------
-----------------------------                                Refer Reply To:
                                                             CC:PSI:B01
                                                             PLR-129094-18
                                                             Date:
                                                             April 18, 2019




LEGEND:


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

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

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

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

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

Agreement         = ------------------------------------------------------------------------------------------

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

Amendment = ----------------------------------------------------------------------------------------------------------------
            ----------------------------------------------------------------------------------------------------------------
            -----------------------------------------------------------------------------

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


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

This letter responds to a letter dated September 26, 2018, submitted on behalf of X,
requesting rulings under § 1362(f) of the Internal Revenue Code.

Facts

The information submitted states that X is a limited liability company organized under
the laws of State on Date 1. X made elections to be treated as an association taxable as
a corporation and to be an S corporation effective Date 2.

On Date 3, the original founding members of X entered into Agreement. Agreement
provided that all distributions would be made to the members in proportion to their
respective membership interests, including upon liquidation. On Date 4, the members
adopted Amendment, which stated that upon liquidation, distributions would be paid to
members with positive capital accounts in accordance with their respective positive
capital account balances, as adjusted pursuant to Section 704 of the Code. On Date 5,
Amendment was amended to correct the liquidating distribution language and provide
for distributions on a pro rata basis in accordance with membership ownership
percentages.

X represents that the termination of X’s S corporation election was inadvertent and not
motivated by tax avoidance. X further represents that since Date 2, X and its members
have filed all returns consistent with X’s status as an S corporation. X also represents
that since Date 2, all distributions were made to the members based on their pro rata
shares of ownership of X. X and its members have agreed to make such adjustments
consistent with the treatment of X as an S corporation as 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 such 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 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 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 for which the election was made or the termination occurred is a
small business corporation or (B) to acquire the shareholder consents, and (4) the
corporation for which the election was made or the termination occurred, 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.

Section 1.1361-1(l)(1) of the Income Tax Regulations provides that a corporation
generally is 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,
the governing provisions).

Conclusion

Based solely on the facts submitted and representations made, we conclude that X’s S
corporation election terminated on Date 4 due to provisions in Amendment. However,
we conclude that such termination was inadvertent within the meaning of § 1362(f).
Therefore, pursuant to the provisions of § 1362(f), X will be treated as an S corporation
effective Date 4, and thereafter, provided that X is otherwise eligible to be an S
corporation and provided that the election was not otherwise terminated.

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. In particular, no opinion is expressed on whether X otherwise qualifies as an
S corporation.

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 the 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.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
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 your authorized representatives.

                                       Sincerely,


                                       Joy C. Spies
                                       Senior Technician Reviewer, Branch 1
                                       (Passthroughs & Special Industries)




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