Ineligible shareholder received inadvertent S termination relief

Plain-English summary

An S corporation transferred shares to a person that was not an eligible S corporation shareholder, terminating its S election. The corporation represented that the termination was inadvertent and was not motivated by tax avoidance or retroactive tax planning. It and its shareholders agreed to make any adjustments required by the IRS that were consistent with continuous S corporation treatment. The IRS granted relief under section 1362(f) and treated the corporation as continuing to be an S corporation from the transfer date, provided the original election was valid and was not otherwise terminated.

Ruling snapshot

• Question: Could the corporation retain S status after shares were transferred to an ineligible shareholder?
• Outcome: approved, with continuous S treatment subject to the stated conditions
• Key authorities: IRC §§ 1361, 1362(f); Treas. Reg. § 1.1362-4

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 201931004                                               Third Party Communication: None
Release Date: 8/2/2019                                          Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                                Person To Contact:
---------------------                                           ---------------------------, ID No. ---------------
---------------------                                           -----------------
---------------------------------------------------             Telephone Number:
-------------------------------                                 ----------------------
                                                                Refer Reply To:
                                                                CC:PSI:B03
                                                                PLR-130334-18
                                                                Date:
                                                                April 24, 2019

Legend

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

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

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

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

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


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

This letter responds to a letter dated October 4, 2018, and subsequent correspondence,
submitted on behalf of X by its authorized representative, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

                                                        FACTS

The information submitted states that X was incorporated under the laws of State on
Date 1 and elected to be treated as an S corporation effective as of that date. On Date
2, shares of X were transferred to A. A was not an eligible S corporation shareholder as
of the date of the transfer, thereby causing X’s S corporation election to terminate on
Date 2.

X represents that the termination of its S corporation election was inadvertent and not
motivated by tax avoidance or retroactive tax planning. X and its shareholders have
PLR-130334-18                                2

agreed to make any adjustments that the Commissioner may require, 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)(B) provides that, for purposes of subchapter S, the term “small
business corporation” means a domestic corporation which is not an ineligible
corporation and which does not 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.

Section 1362(d)(2)(A) provides that an election under § 1362(a) will be terminated
whenever (at any time on or after the 1st day of the 1st taxable year for which the
corporation is an S corporation) such corporation ceases to be a small business
corporation.

Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (3), (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 the
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, and (4) the corporation for which the termination
occurred and each person who was a shareholder of such 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 termination, the corporation will be treated as an S
corporation during the period specified by the Secretary.

Section 1.1362-4(b) provides, in relevant part, that for purposes of § 1.1362-4(a), the
determination of whether a termination 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 termination was
inadvertent. The fact that the terminating event was not reasonably within the control of
the corporation and was not part of a plan to terminate the election, or the fact that the
terminating event or circumstance took place without the knowledge of the corporation,
notwithstanding its due diligence to safeguard itself against such an event or
circumstance, tends to establish that the termination was inadvertent.
PLR-130334-18                               3

Section 1.1362-4(d) provides, in part, that the Commissioner may require any
adjustments that are appropriate. In general, the adjustments should be consistent with
the treatment of the corporation as an S corporation during the period specified by the
Commissioner.

                                     CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the termination of X’s S corporation election on Date 2 was inadvertent within the
meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X
will be treated as continuing to be an S corporation from Date 2, provided X’s S
corporation election was valid and provided that the election was not otherwise
terminated under § 1362(d).

Except as specifically ruled above, we express no opinion concerning the federal tax
consequences of the transactions described above under any other provisions of the
Code. This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent. Pursuant to a power of attorney
on file, a copy of this letter is being sent to X’s authorized representative.



                                     Sincerely,



                                     Adrienne M. Mikolashek
                                     Chief, Branch 3
                                     Office of the Associate Chief Counsel
                                     (Passthroughs & Special Industries)



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


cc: