IRS grants inadvertent S corporation termination relief after a partnership bought shares

Plain-English summary

An S corporation's election terminated when a partnership, which was not an eligible S corporation shareholder, acquired some of its shares. After discovering the problem, the corporation and its shareholders had the partnership distribute all of those shares to two individual partners who were eligible shareholders. They represented that the termination was inadvertent, that returns had consistently treated the corporation as an S corporation, and that the affected income had been allocated as if the individuals directly owned the shares. The IRS granted relief under section 1362(f) and treated the corporation as continuing to be an S corporation from the termination date. The relief depended on the original election being valid, no other termination having occurred, and the parties making any adjustments the IRS required.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after an ineligible partnership acquired its shares?
• Outcome: approved (the corporation was treated as continuing its S status, subject to stated conditions)
• 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: 202027001                                                Third Party Communication: None
 Release Date: 7/2/2020                                           Date of Communication: Not Applicable
 Index Number: 1362.00-00, 1362.01-00,
               1362.02-00, 1362.04-00                             Person To Contact:
                                                                  --------------, ID No. -----------------
 ----------------------------                                     Telephone Number:
 --------------------------------------                           --------------------
 ----------------------------------                               Refer Reply To:
 -------------------------------------                            CC:PSI:B01
                                                                  PLR-121646-19
                                                                  Date:
                                                                  February 26, 2020

 Legend

                          -----------------------------------------
   X           =          ----------------------
   y           =          --
   LLC         =          ---------------------------------
   A           =          -------------------
   B           =          -----------------------------------------
   Date 1      =          ---------------------
   Date 2      =          -----------------
   Date 3      =          ------------------------
   Date 4      =          ------------------
   Date 5      =          -------------------
   State       =          ------------

-------------------

This letter responds to a letter dated September 10, 2019, submitted on behalf of X by
X’s 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 on Date
1 and elected to be an S corporation effective Date 2.

On Date 3, y% of the shares in X were 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 4, X learned that the sale of shares to LLC terminated X’s S election. On
Date 5, X and its shareholders took remedial action by having LLC distribute all of its
shares in X to A and B, individual partners of X. X represents that both A and B are
eligible S corporation shareholders.
PLR-121646-19                                2

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 also represents that X and its shareholders intended for X to be an S
corporation on Date 2. X further represents that since Date 2, X has filed all returns
consistent with X’s status as an S corporation and the income of LLC attributable to X
has been allocated to A and B as though A and B owned the LLC shares directly. 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, in relevant part, that if (1) an election under § 1362(a) by any
corporation was terminated under paragraph (2) or (3) of § 1362(d), (2) the Secretary
determines that the circumstances resulting in such termination were inadvertent, (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
termination, steps were taken so that the corporation is once more a small business
corporation, 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 any adjustments (consistent with the treatment of the corporation as an S
corporation) as may be required by the Secretary with respect to the period, then,
notwithstanding the circumstances resulting in the termination, the corporation will be
treated as continuing to be an S corporation 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 3 when the X stock was sold to LLC. We further
conclude that the termination was inadvertent within the meaning of § 1362(f).
PLR-121646-19                                 3

Accordingly, under § 1362(f), X will be treated as continuing to be an S corporation on
and after Date 3, 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, 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.

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,


                                       Joy Spies
                                      Joy Spies
                                      Senior Technician Reviewer, Branch1
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)




Enclosures (2)

       Copy of Letter
       Copy for 6110 purposes


cc: