Invalid S corporation and QSub elections receive inadvertent-election relief

Plain-English summary

A business trust intended to elect corporate and S corporation status and to elect three subsidiaries as qualified subchapter S subsidiaries. The forms were invalid because their signature dates preceded the taxpayer's ownership of the entities. The trust agreement also created a prohibited second class of stock, independently making the S election ineffective and preventing valid QSub elections. The taxpayer had filed consistently with the intended status and represented that the defects were inadvertent. The IRS granted section 1362(f) relief, conditioned on the taxpayer filing corrected Forms 8832, 2553, and 8869 and amending the trust agreement within 120 days.

Ruling snapshot

• Question: Were the ineffective S corporation and QSub elections caused by premature signatures and a second class of stock inadvertent?
• Outcome: approved (the intended S and QSub treatment was restored subject to six corrective conditions)
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

 Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202021002                                           Third Party Communication: None
 Release Date: 5/22/2020                                     Date of Communication: Not Applicable
 Index Number: 1361.00-00, 1361.01-04,
               1361.01-05, 1361.05-00,                       Person To Contact:
               1362.01-00, 1362.04-00                        --------------, ID No. -----------------
                                                             Telephone Number:
                                                             --------------------
                                                             Refer Reply To:
 -------------------------------
                                                             CC:PSI:B01
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                                                             PLR-118689-19
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                                                             Date:
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                                                             February 5, 2020




 Legend

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 X           =
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 Y           =
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 Z           =
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 W           =
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 Date 1      =    -------------------
 Date 2      =    ----------------
 State       =    --------------------




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

       This responds to a letter dated August 1, 2019 submitted on behalf of X by X’s
authorized representatives, requesting relief under § 1362(f) of the Internal Revenue
Code (the Code).

                                                     Facts

       According to the information submitted and representations made, X was formed
as a business trust under the laws of State. X filed Form 8832, Entity Classification
Election intending to be treated as an association taxable as a corporation effective on
Date 1. X subsequently filed Form 2553, Election by a Small Business Corporation for X
intending to be treated as an S corporation effective on Date 1. X, as the parent S
corporation filed Form 8869, Qualified Subchapter S subsidiary Election, intending for Y
PLR-118689-19                                 2

to be treated as a qualified subchapter S subsidiary (“QSub”) effective on Date 1. X, as
the parent S corporation filed Forms 8869, intending for Z and W respectively to be
treated as QSubs effective on Date 2. However, X later discovered that these elections
were invalid because the signature dates on the filed Form 8832, Form 2553 and Forms
8869 preceded the ownership of X, Y, Z and W. In addition, X discovered that X’s S
corporation election was also ineffective because X’s trust agreement created a second
class of stock.

       X represents that since Date 1, it has not declared a preferential dividend to any
class of stock and it has filed its federal income tax returns consistent with it being an S
corporation. X further represents that X’s S election and QSub elections were
inadvertently invalid and the invalid elections were 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) 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 1.1361-1(l)(1) provides, in part, that a corporation is generally 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 laws, and binding agreements relating to distribution and liquidation
proceeds (collectively, governing provisions).

       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.
PLR-118689-19                                3

        Section 1361(b)(3)(A) generally provides that a QSub shall not be treated as a
separate corporation and 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) defines a QSub as a domestic corporation which is not an
ineligible corporation, if 100 percent of the stock of the corporation is owned by the S
corporation, and the S corporation elects to treat the corporation as a QSub.

        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),
(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 is an S corporation or a QSub,
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 or a QSub) 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 or a
QSub during the period specified by the Secretary.

                                       Conclusion

        We conclude that due to the signature error, X’s S election and QSub elections
for Y, Z and W were invalid and, thus not effective. Also, even if these elections were
effective, we conclude that X’s S election and QSub elections for Y, Z and W would be
invalid because X’s trust agreement created a second class of stock and thus, X’s S
election was ineffective and as a result, X was an ineligible parent to make QSub
elections. We also conclude that these invalid elections were inadvertent within the
meaning of § 1362(f). Accordingly, under § 1362(f), X will be treated to be an S
corporation on and after Date 1, Y will be treated to be a QSub on and after Date 1 and
Z and W will be treated to be QSubs on and after Date 2, provided that X’s S
corporation election and QSub elections for Y, Z and W are valid and not otherwise
terminated under § 1362(b). This letter ruling is subject to the following conditions: No
later than 120 days from the date of this letter, (1) X must file a completed Form 8832 to
be treated as an association taxable as a corporation effective on Date 1 with the
appropriate service center; (2) X must file a completed Form 2553 for X to be treated as
an S corporation effective on Date 1 with the appropriate service center; (3) X, as the
parent S corporation must file a completed Form 8869 for Y to be treated as a QSub
effective on Date 1 with the appropriate service center; (4) X, as the parent S
corporation must file a completed Form 8869 for Z to be treated as a QSub effective on
PLR-118689-19                                 4

Date 2 with the appropriate service center; (5) X, as the parent S corporation must file a
completed Form 8869 for W to be treated as a QSub effective on Date 2 with the
appropriate service center; and (6) X must amend the trust agreement to remove the
language pertaining to the second class of stock. If these conditions are not met, then
this ruling is null and void. Furthermore, if these conditions are not met, X must send
notification that its S election and QSub elections have terminated to the service center
with which X’s S election and QSub elections were filed.

       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. § 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 representative.

                                      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: