Corporation received inadvertent invalid S election relief

Plain-English summary

A corporation’s S election was ineffective because its governing documents created a second class of stock. The corporation and its shareholders later amended the documents to remove the offending provisions, had made all distributions proportionately, and had filed consistently with S corporation treatment. The IRS found that the invalid election was inadvertent and not motivated by tax avoidance or retroactive planning. It treated the corporation as an S corporation from the stated effective date onward, provided the election was not otherwise terminated and any required adjustments were made.

Ruling snapshot

• Question: May the corporation receive relief for an S election invalidated by a second class of stock?
• Outcome: approved as an inadvertent invalid election under section 1362(f)
• Key authorities: IRC §§ 1361 and 1362(f)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201938007                                              Third Party Communication: None
Release Date: 9/20/2019                                        Date of Communication: Not Applicable
Index Number: 1361.01-05, 1362.00-00,
              1362.01-00                                       Person To Contact:
                                                               -------------------, ID No. ------------------
------------------------                                       Telephone Number:
---------------------                                          --------------------
-----------------------                                        Refer Reply To:
----------------------------                                   CC:PSI:B01
                                                               PLR-133729-18
                                                               Date:
                                                               May 14, 2019




LEGEND

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

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

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

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

State                      =        ---------



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

This responds to a letter dated October 15, 2018, submitted on behalf of X, by X’s
authorized representative, requesting relief under section 1362(f) of the Internal
Revenue Code (the Code).

FACTS

According to the information submitted and representations made within, X was formed
on Date 1 and made an S election effective Date 2, under the laws of State.

X’s S corporation election was ineffective because X’s governing documents create a
second class of stock. On Date 3, X and its shareholders amended its governing
documents to remove the provisions causing a second class of stock.

PLR-133729-18                                2


X represents that the invalidity of its S election was inadvertent and was not motivated
by tax avoidance or retroactive tax planning. X represents that all of X’s distributions to
shareholders have been pro rata in accordance with their ownership interests. X also
represents that X and its shareholders agree to make any adjustments required as a
condition of obtaining relief under the inadvertent invalid election rule as provided under
§ 1362(f) of the Code that may be required by the Secretary. X and its shareholders
represent that they have filed all returns consistently with X being 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 the 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 1 class of stock.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 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 not effective for the taxable year for which made by reason of a failure
to meet the requirements of § 1361(b), (2) the Secretary determines that the
circumstances resulting in the ineffectiveness were inadvertent, (3) no later than a
reasonable period of time after the discovery of the circumstances resulting in the
ineffectiveness, steps were taken so that the corporation for which the election was
made is a small business corporation, and (4) the corporation for which the election was
made, and each person who was a shareholder in such corporation at any time during
the period specified by § 1362(f), agrees to makes 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, the corporation is treated as an S corporation during the period
specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude X’s S
election was ineffective. We further conclude that the ineffectiveness of X’s S
corporation election was inadvertent within the meaning of

PLR-133729-18                                3

§ 1362(f). Therefore, X will be treated as an S corporation effective Date 1 and
thereafter, provided X’s S corporation election is not otherwise terminated under
§ 1362(d).

Except as specifically ruled upon above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it 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 your authorized representative.

                                      Sincerely,


                                      Faith P. Colson
                                      Faith P. Colson
                                      Senior Counsel, Branch 1
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)



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