S corporation receives inadvertent-termination relief

Plain-English summary

An eligible S corporation shareholder transferred all of its shares in another S corporation to a wholly owned S corporation. Because an S corporation cannot be a shareholder of another S corporation, the transfer caused the lower corporation's S election to terminate. After discovering the problem, the parties restored the shares to the eligible shareholder. They represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive tax planning, and that they would make any required adjustments. The IRS granted section 1362(f) relief and treated the corporation as continuing to be an S corporation from the termination date, assuming its election was otherwise valid.

Ruling snapshot

• Question: Was the S election termination caused by an ineligible corporate shareholder inadvertent under section 1362(f)?
• Outcome: approved (continuous S corporation treatment granted)
• Key authorities: IRC §§ 1361(a), 1361(b), 1362(d), 1362(f)

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202017020                                             Third Party Communication: None
 Release Date: 4/24/2020                                       Date of Communication: Not Applicable
 Index Number: 1362.00-00,
 1362.01-00, 1362.02-00                                        Person To Contact:
                                                               --------------, ID No. -----------------
                                                               Telephone Number:
                                                               -------------- -------
 -------------------------------------------                   Refer Reply To:
 ----------------------------------                            CC:PSI:B01
 --------------------------------                              PLR-118391-19
 ----------------------------                                  Date:
                                                               November 22, 2019




Legend
                                           ----------------------------------
  X                            =           ----------------------------------
                                           ------------------------
                                           ---------------------
  Y                            =
                                           -------------------------
                                           ----------------------
  Z                            =
                                           ------------------------
  Date 1                       =           ----------------------
  Date 2                       =           ---------------------
  Date 3                       =           --------------
  Date 4                       =           ----------------
  State                        =           ------------


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

       This responds to a letter dated August 5, 2019 submitted on behalf of X by X’s
authorized representatives, requesting inadvertent termination relief under § 1362(f) of
the Internal Revenue Code (the Code).

                                                      Facts

        According to the information submitted and representations made, X was formed
under the laws of State and made an S election effective on Date 1. On Date 2, Y, an
eligible S corporation shareholder transferred all of Y’s shares in X to Z, an S
corporation wholly owned by Y. On Date 3, X discovered that Z as an S corporation was

PLR-118391-19                                2

an ineligible shareholder that caused X’s S election to terminate effective Date 2. On
Date 4, X and its shareholders took remedial action by having Z transfer all of its shares
in X to Y, an eligible S corporation shareholder.

      X represents that X's S election termination on Date 2 was inadvertent and not
motivated by tax avoidance or retroactive tax planning. X and its shareholders have
agreed to make any adjustments required as a condition of obtaining relief under the
inadvertent termination rule of § 1362(f).

                                    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, have a nonresident alien as a shareholder, and 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 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 is a small business corporation or (B) to acquire
the 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 the ineffectiveness or
termination, the corporation will be treated as an S corporation during the period
specified by the Secretary.

                                           Conclusion

PLR-118391-19                                 3

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 2 because X had an ineligible
shareholder. We further conclude that the termination was inadvertent within the
meaning of § 1362(f).

      Accordingly, under § 1362(f), X will be treated as continuing to be an S corporation
on and after Date 2, provided that X’s S corporation election was valid and not otherwise
terminated under § 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 taxpayers requesting 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 the power of attorney on file with this office, we are sending a copy of
this letter to X’s authorized representatives.


                                      Sincerely,


                                      David R. Haglund
                                      David R. Haglund
                                      Branch Chief, Branch 1
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)




Enclosures (2)

       Copy of Letter
       Copy for 6110 purposes


cc: