S corporation status continues after an inadvertent partnership ownership period

Plain-English summary

An S corporation sold part of its ownership to a limited liability company taxed as a partnership. Because a partnership is not an eligible S corporation shareholder, the transfer terminated the corporation's S election. After discovering the problem, the partnership distributed all of its shares to individual management members who were eligible shareholders. The corporation represented that the error was inadvertent, was not motivated by tax avoidance or retroactive planning, and that it and its shareholders would make any required adjustments. The IRS granted relief under section 1362(f), treating the corporation as continuously maintaining S status from the date of the disqualifying transfer, assuming the election was otherwise valid.

Ruling snapshot

• Question: Was the S election's termination from temporary ownership by a partnership inadvertent under section 1362(f)?
• Outcome: approved (the corporation is treated as continuing to be an S corporation)
• Key authorities: IRC §§ 1361(a), 1361(b), 1362(d), and 1362(f)

Full text (IRS public release)

    Internal Revenue Service                                      Department of the Treasury
                                                                  Washington, DC 20224

    Number: 202021016                                             [Third Party Communication:
    Release Date: 5/22/2020                                       Date of Communication: Month DD, YYYY]
    Index Number: 1362.00-00, 1362.01-01,
                  1362.02-00                                      Person To Contact:
                                                                  --------------, ID No. -----------------
    --------------------------------                              Telephone Number:
    ----------------------------------------------                --------------------
    -----------------------------                                 Refer Reply To:
    ---------------------------                                   CC:PSI:B01
                                                                  PLR-120447-19
                                                                  Date:
                                                                  January 23, 2020




Legend

X                   =        ----------------------------------------------
                             -----------------------
LLC                 =        -------------------------------------------------
                             -----------------------
Y                   =        ----
Date 1              =        ----------------------
Date 2              =        ----------------------
Date 3              =        ---------------------
Date 4              =        ----------------------
State               =        --------------
A                   =        --------------------
                             -------------------------
B                   =        -----------------
                             -------------------------
C                   =        ---------------------
                             -------------------------
D                   =        ------------------
                    ----------------------------------
E                   =        ------------------
                             -------------------------
F                   =        -------------------
                             -------------------------
G                   =        --------------------
                             -------------------------
H                   =        ------------------
                             -------------------------
I                   =        --------------
                             -------------------------
PLR-120447-19                                2

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

        This letter responds to a letter dated September 3, 2019, submitted on behalf of X
by its authorized representatives, requesting inadvertent termination relief under § 1362(f)
of the Internal Revenue Code (Code).

                                           Facts

      The information submitted discloses that X was formed under the laws of State
and elected to be an S corporation effective Date 1.

       On Date 2, Y% of the interest in X was sold to LLC, a partnership for federal tax
purposes. LLC, as a partnership, was an ineligible shareholder of an S corporation. On
or about Date 3, X learned that the sale of interest to LLC terminated X’s S election. On
Date 4, X and its shareholders took remedial action by having LLC distribute all of its
interests in X to A, B, C, D, E, F, G, H and I, individual management members. X
represents that A, B, C, D, E, F, G, H and I are eligible S corporation shareholders.

       X represents that the circumstances resulting in the termination of X’s S
corporation election were inadvertent and not motivated by tax avoidance or retroactive
tax planning. X further represents that X and its shareholders have agreed to make any
adjustments 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 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 that if (1) an election under subsection (a) or section
1361(b)(3)(B)(ii) by any corporation (A) was not effective for the taxable year for which
made (determined without regard to subsection (b)(2)) by reason of a failure to meet the
requirements of section 1361(b) or to obtain shareholder consents, or (B) was terminated
under paragraph (2) or (3) of subsection (d) or section 1361(b)(3)(C); (2) the Secretary
determines that the circumstances resulting in such ineffectiveness or termination were
PLR-120447-19                                3

inadvertent; (3) no later than a reasonable period of time after discovery of the
circumstances resulting in such 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 qualified subchapter S subsidiary, as the case may be, or (B)
to acquire the required shareholder consents; and (4) the corporation for which the
election was made or the termination occurred, and each person who was a shareholder
in such corporation at any time during the period specified pursuant to this subsection,
agrees to make such adjustments (consistent with the treatment of such corporation as
an S corporation or a qualified subchapter S subsidiary, as the case may be) as may be
required by the Secretary with respect to such period, then, notwithstanding the
circumstances resulting in such ineffectiveness or termination, such corporation shall be
treated as an S corporation or a qualified subchapter S subsidiary, as the case may be
during the period specified by the Secretary.

                                        Conclusion

      Based solely on the information submitted and the representations made, we
conclude that X’s S election terminated on Date 2 when an interest in X was sold to LLC.
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 or imply no opinion as to the federal
income tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed concerning whether X is a subchapter S
corporation for federal purposes.

      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.

       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.
PLR-120447-19                                 4


        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,


                                      Laura Fields
                                      Laura Fields
                                      Senior Technician Reviewer, Branch 1
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries



Enclosures (2)

       Copy of Letter
       Copy for 6110 purposes


cc: