IRS grants relief for an inadvertent S corporation termination

Plain-English summary

An S corporation made annual nonresident state income tax payments for certain shareholders in amounts that were disproportionate to their ownership interests. The corporation represented that those payments created a second class of stock and terminated its S election. It and its shareholders had always intended S corporation treatment, consistently filed that way, took corrective action, and agreed to make any required adjustments. The IRS found the termination inadvertent under IRC § 1362(f) and treated the corporation as an S corporation from the termination date forward, provided its election had not otherwise terminated. The ruling does not decide whether the corporation otherwise qualifies for S status.

Ruling snapshot

• Question: Was the S corporation's termination from disproportionate shareholder tax payments inadvertent under § 1362(f)?
• Outcome: Approved. The corporation remains treated as an S corporation from the termination date forward.
• 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: 202103010                                      Third Party Communication: None
Release Date: 1/22/2021                                Date of Communication: Not Applicable
Index Number: 1362.00-00
                                                       Person To Contact:
------------------------------------------             -------------------, ID No. -----------------
------------------------------------------------       Telephone Number:
--------------------------                             --------------------
-------------------------------------------            Refer Reply To:
                                                       CC:PSI:B03
                                                       PLR-112399-20
                                                       Date:
                                                       October 26, 2020



X:                 -----------------------------
                  ------------------------
Date 1:           --------------------------
Date 2:           ---------------------
Date 3 :          ---------------------
State:            ------



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

      This letter responds to your letter dated May 22, 2020, and subsequent
correspondence, submitted on behalf of X, by X’s representatives, requesting relief
under § 1362(f) of the Internal Revenue Code.

                                                   FACTS

        The information submitted states that X was formed on Date 1 under the laws of
State, and elected to be classified as an S corporation effective Date 2. X’s articles of
incorporation provide that X shall maintain only one class of stock with identical rights to
distributions and liquidation proceeds.

      X states that, beginning on Date 3, it made annual non-resident income tax
payments to certain states on behalf of its shareholders, and that these payments were
disproportionate to the shareholders’ ownership interests. X represents that these
payments created a second class of stock, and thus, caused the termination of X’s S
corporation election effective Date 3.

       X further represents that X and its shareholders intended for X to be an S
corporation at all times since its formation, and that X and its shareholders have filed all
returns consistent with the treatment of X as an S corporation at all times since its
formation. X and its shareholders agree to make any adjustments required as a

condition of obtaining relief under § 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 the year.

       Section 1361(b)(1) defines a “small business corporation” as a domestic
corporation which is not an ineligible corporation which does not (A) have more than
100 shareholders, (B) have as a shareholder a person (other than an estate, and 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 one
class of stock.

      Section 1362(a)(1) provides that, except as provided in § 1362(g), a small
business corporation may elect, in accordance with § 1362, to be an S corporation.

       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 estate, and 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 first day of the first taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation. Section 1362(d)(2)(B) further provides that the termination shall
be effective on and after the date of cessation.

      Treas. Reg. § 1.1361-1(l)(1) of the Income Tax Regulations provides 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.

        Treas. Reg. § 1.1361-1(l)(2)(i) provides, in part, 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). Although a corporation is not treated as
having more than one class of stock so long as the governing provisions provide for
identical distribution and liquidation rights, any distributions, (including actual,
constructive, or deemed distributions) that differ in timing and amount are to be given
appropriate tax effect in accordance with the facts and circumstances.


        Section 1362(f) provides, in relevant part, 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), (2) the Secretary determines that the circumstances
resulting in the ineffectiveness were inadvertent, (3) no later than a reasonable period of
time after discovery of the circumstances resulting in the ineffectiveness, steps were
taken so that the corporation is 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 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, the corporation will be treated as an S corporation during the
period specified by the Secretary.

                                     CONCLUSION

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 3 as a result of X having more than
one class of stock. We further conclude that this termination was inadvertent within the
meaning of § 1362(f).

       X has taken corrective action so that it meets the requirements of a small
business corporation under § 1361(b). Therefore, we determine that pursuant to the
provisions of § 1362(f), X will be treated an S corporation effective Date 3 and
thereafter, provided that its S corporation election has not otherwise terminated under
§ 1362(d).

       Except as specifically ruled upon above, we express or imply no opinion
concerning the federal tax consequences of the facts described above under any other
provision of the Code. Specifically, no opinion is expressed or implied as to whether X is
otherwise eligible to be an S corporation.

       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 this request, it is subject to verification on examination.

      This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that this ruling may not be used or cited as precedent.


       Pursuant to a power of attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                               Sincerely,




                                               Adrienne M. Mikolashek
                                               Chief, Branch 3
                                               Office of the Associate Chief Counsel
                                               (Passthroughs and Special Industries)


Enclosures (2)
      Copy of this letter
      Copy for § 6110 purposes


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