S corporation receives relief after a partnership temporarily held its shares

Plain-English summary

An S corporation sold some of its ownership units to a limited liability company taxed as a partnership. Because a partnership is not an eligible S corporation shareholder, the sale terminated the corporation's S election. After discovering the problem, the partnership distributed all of the units to two individual members who were eligible shareholders. The corporation represented that the termination was inadvertent, was not tax-motivated, and had been reported as though the individuals owned the units directly. The IRS granted relief under IRC § 1362(f), treating the corporation as continuously eligible for S status from the termination date, assuming its election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Question: Can the corporation retain continuous S status after an ineligible partnership temporarily acquired its units?
• Outcome: Approved as an inadvertent termination
• Key authorities: IRC §§ 1361(a), 1361(b), 1362(d)(2), and 1362(f)

Full text (IRS public release)

    Internal Revenue Service                                   Department of the Treasury
                                                               Washington, DC 20224

    Number: 202110003                                          Third Party Communication:
    Release Date: 3/12/2021                                    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:B3
                                                               PLR-112091-20
                                                               Date:
                                                               November 17, 2020




Legend

X         = ----------------------------
-----------------------------------

Y          = -----------------------------------------------

A         = ----------------
-------------------------------------

B         = ------------------------------------
-------------------------------------

State =-------

Date 1 = ----------------------

Date 2 = ------------------

Date 3 = --------------------------

n         = ---


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

This letter responds to a letter dated May 20, 2020, and subsequent correspondence,
submitted on behalf of X by X’s authorized representatives, requesting inadvertent
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PLR-112091-20

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, n% of the units in X were sold to Y, a limited liability company classified as a
partnership for federal tax purposes. Y, as a partnership, was an ineligible shareholder of
an S corporation. On Date 3, X and its shareholders took remedial action by having Y
distribute all its units in X to A and B, individual members of X. X represents that both A
and B are eligible S corporation shareholders and 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 beginning on Date 1.

X further represents that since Date 2, X has filed all returns consistent with X’s status
as an S corporation and the items of Y attributable to X have been allocated to A and B
as though A and B owned the Y units 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
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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 corporation election terminated on Date 2 when the X stock was sold to Y. 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, 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 representatives.


                                       Sincerely,


                                       Richard T. Probst
                                       Senior Technician Reviewer, Branch 3
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)



Enclosures (2)

        Copy of Letter
        Copy for 6110 purposes


cc: