Ineffective QSub election receives inadvertent relief

Plain-English summary

An S corporation acquired all the stock of another S corporation as part of a purported reorganization, after which the subsidiary converted to a limited liability company. The parent intended to elect qualified subchapter S subsidiary status for the subsidiary, but the election was ineffective because the subsidiary did not meet all QSub requirements when the election was made. The parent represented that the problem was inadvertent, did not involve tax avoidance or retroactive planning, and had not produced inconsistent federal returns. The IRS granted relief under section 1362(f) and treated the subsidiary as a QSub from the intended effective date, provided the election was otherwise valid and was not later terminated. The ruling did not decide whether the subsidiary otherwise qualified or whether the reorganization was valid under section 368(a)(1)(F).

Ruling snapshot

• Question: May an ineffective QSub election be treated as effective from its intended date under the inadvertent-election rules?
• Outcome: approved
• Key authorities: IRC §§ 368(a)(1)(F), 1361(b)(3), 1362(f); Treas. Reg. § 1.1361-3(a)(1)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202015003 Third Party Communication: None
Release Date: 4/10/2020 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00 Person To Contact:
-------------------------,
---------------------------- ID No. ---------------
-------------------------------- Telephone Number:
----------------------------------- --------------------
----------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-110393-19
Date:
October 24, 2019

LEGEND

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

Sub = ------------------------------------------------

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

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

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

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

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

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

    This letter responds to a letter dated April 30, 2019, and supplemental

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 and representations within, X was

organized under the laws of State on Date 1, and made an election to be a subchapter
S corporation effective Date 2. Sub was organized under the laws of State on Date 3,
and made an election to be a subchapter S corporation effective Date 3. On Date 2,
incident to what X represents was part of a reorganization under § 368(a)(1)(F), Sub's
shareholders contributed all of their stock in Sub to X, thereby causing Sub to become a
PLR-110393-19 2

wholly owned subsidiary of X. Sub then converted to a limited liability company under
State law on Date 4, and by default was treated as a disregarded entity for federal tax
purposes. Afterwards, X made an election to treat Sub as a qualified subchapter S
subsidiary (“QSub”) effective on Date 2. However, X discovered that its election to treat
Sub as a QSub was ineffective due to Sub's failure to meet all the requirements of §
1361(b)(3)(B) at the time the election was made.

   X represents that the ineffective QSub election for Sub was inadvertent and not

the result of tax avoidance or retroactive tax planning. X further represents that no
federal tax return of any person has been filed inconsistent with a valid QSub election
having been made for Sub effective Date 2. Sub and X have agreed to make any
adjustments required by the Service consistent with the treatment of Sub as a QSub.

LAW AND ANALYSIS

   Section 1361(b)(3)(A) provides that, except as provided in regulations prescribed

by the Secretary, for purposes of the Code-(i) a corporation which is a QSub shall not
be treated as a separate corporation, and (ii) all assets, liabilities, and items of income,
deduction, and credit of a QSub shall be treated as assets, liabilities, and such items (as
the case may be) of the S corporation.

  Section 1361(b)(3)(B) provides that the term “QSub” means any domestic

corporation which is not an ineligible corporation (as defined in § 1361(b)(2)), if (i) 100
percent of the stock of such corporation is held by the S corporation, and (ii) the S
corporation elects to treat such corporation as a QSub.

    Section 1.1361-3(a)(1) of the Income Tax Regulations provides that the

corporation for which a QSub election is made must meet all the requirements of §
1361(b)(3)(B) at the time the election is made and for all periods for which the election
is to be effective.

    Section 1362(f) provides that if (1) an election under § 1362(a) or §

1361(b)(3)(B)(ii) 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) or § 1361(b)(3)(C), (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 a
QSub, as the case may be, 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 or a QSub, as the case may be) as may be
required by the Secretary with respect to such period, then, notwithstanding the
PLR-110393-19 3

circumstances resulting in the ineffectiveness or termination, the corporation will be
treated as an S corporation or a QSub, as the case may be during the period specified
by the Secretary.

CONCLUSION

    Based solely on the facts submitted and representations made, we conclude that

X’s election to treat Sub as a QSub on Date 2 was ineffective. We also conclude that
the circumstances resulting in the ineffectiveness of the QSub election were inadvertent
within the meaning of § 1362(f). Thus, under the provisions of § 1362(f), Sub will be
treated as a QSub effective on Date 2, provided that Sub's QSub election was otherwise
valid and not otherwise terminated under § 1361(b)(3)(C).

   Except as expressly provided herein, we express or imply no opinion concerning

the federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, we express or imply no opinion on whether Sub
was otherwise eligible to be treated as a QSub or on the validity of the reorganization
under § 368(a)(1)(F) or its tax consequences.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer an 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 or examination.

   This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

of the Code provides that it may not be used or cited as precedent.

   Pursuant to a power of attorney on file, 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 for § 6110 purposes

cc: