Inadvertently ineffective QSub election receives relief

Plain-English summary

After an asserted Section 368(a)(1)(F) reorganization, a subsidiary merged into a limited liability company treated as disregarded for federal tax purposes. The parent later tried to make a qualified subchapter S subsidiary election effective before that merger. The election was technically ineffective because the subsidiary was not a corporation when the election was made. The IRS found the failure inadvertent, with no inconsistent returns or tax-avoidance purpose, and granted relief under Section 1362(f). The subsidiary will be treated as a QSub from the requested date if the election was otherwise valid and did not later terminate.

Ruling snapshot

• Question: May an inadvertently ineffective QSub election receive relief under Section 1362(f)?
• Outcome: Approved. The subsidiary is treated as a QSub from the requested effective date, subject to the stated conditions.
• Key authorities: IRC §§ 1361, 1362(f), and 368(a)(1)(F); Rev. Rul. 2008-18; Rev. Rul. 64-250

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202114013 Third Party Communication: None
Release Date: 4/9/2021 Date of Communication: Not Applicable
Index Number: 1361.05-00, 1362.00-00
Person To Contact:
------------------------- -----------------------, ID No. -----------------
------------------------------------ Telephone Number:
---------------------------- --------------------
------------------------------------- Refer Reply To:
CC:PSI:03
PLR-117184-20
Date:
January 11, 2021

Legend

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

Sub = --------------------------------------------------------------------------------

State = -------------

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

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

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

Date 4 = -------------------

Date 5 = -------------------

Date 6 = -------------------

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

This letter responds to a letter dated August 3, 2020, and subsequent correspondence,
submitted on behalf of X by its authorized representatives requesting a ruling under
§ 1362(f) of the Internal Revenue Code (Code).

                                                     Facts

PLR-117184-20 2

According to the information submitted, X was organized under the laws of State on
Date 1. Sub was organized under the laws of State on Date 2 and made an election to
be a subchapter S corporation effective Date 3. On Date 4, as part of what X
represents was a reorganization under § 368(a)(1)(F), Sub’s shareholders contributed
all their stock in Sub to X, thereby causing Sub to become a wholly owned subsidiary of
X. Consistent with Rev. Rul. 2008-18, 2008-1 C.B. 674, X was treated as the successor
S corporation to Sub for federal income tax purposes and therefore did not make a new
S election. Sub then merged into a newly formed limited liability company under State
law on Date 5, that was treated as a disregarded entity for Federal tax purposes.
Afterwards, on Date 6, X made an election to treat Sub as a qualified subchapter S
subsidiary (“QSub”) effective on Date 4. However, X discovered that its election to treat
Sub as a QSub was ineffective due to Sub’s failure to meet all the requirements of
§ 1361(b)(3)(B) at the time the election was made. Specifically, Sub was not a
corporation, as defined by § 301.7701-2(b) of the Income Tax Regulations, at the time
the election was made. See Reg. § 1.1361-3(a)(1).

X represents that the ineffective QSub election for Sub was inadvertent and not the
result of tax avoidance or retroactive tax planning. X further represents that no Federal
tax return of any person has been filed inconsistent with a valid QSub election having
been made for Sub effective Date 4. Sub and X have agreed to make any adjustments
required by the Service consistent with the treatment of Sub as a QSub.

                                 Law and Analysis

Section 1361(b)(3)(A) provides that, except as provided in regulations prescribed by the
Secretary, for purposes of the Code-(i) a corporation which is a QSub shall not be
treated as a separate corporation, and (ii) 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) provides that the term “QSub” means any domestic corporation
which is not an ineligible corporation (as defined in § 1361(b)(2)), if (i) 100 percent of
the stock of such corporation is held by the S corporation, and (ii) the S corporation
elects to treat such corporation as a QSub.

Section 1.1361-3(a)(1) provides that the corporation for which a QSub election is made
must meet all the requirements of § 1361(b)(3)(B) at the time the election is made and
for all periods for which the election is to be effective.

Section 1362(f) provides that if (1) an election under § 1362(a) or § 1361(b)(3)(B)(ii) 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)
or (3) or § 1361(b)(3)(C), (2) the Secretary determines that the circumstances resulting
PLR-117184-20 3

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 for which the election was
made or the termination occurred is a small business corporation or a QSub, as the
case may be, or (B) to acquire the shareholder consents, and (4) the corporation for
which the election was made or the termination occurred, 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 the case may be) 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, as the case may be during the period specified by the Secretary.

Rev. Rul. 2008-18, situation 1, holds that, consistent with Rev. Rul. 64-250, 1964-2,
C.B. 333, a reorganization under § 368(a)(1)(F) did not cause the termination of an S
corporation election under § 1362. In Rev. Proc. 2008-18, B, an individual, owns all of
the stock in Y, an S corporation. In Year 1, B forms Newco and contributes all of the Y
stock to Newco. Newco meets the requirements for qualification as a small business
corporation and timely elects to treat Y as a qualified subchapter S subsidiary (QSub),
effective immediately following the transaction. The transaction meets the requirements of a
reorganization under § 368(a)(1)(F). Y’s original S election does not terminate but
continues for Newco. Newco must obtain a new EIN. Y must retain its EIN even though a
QSub election is made for it and must use its original EIN any time the QSub is otherwise
treated as a separate entity for federal tax purposes (including for employment and certain
excise taxes) or if the QSub election terminates.

Rev. Rul. 64-250 holds that a reorganization under § 368(a)(1)(F) did not cause a
termination of an election under former § 1372, the predecessor to § 1362. In that
revenue ruling, an electing small business corporation within the meaning of former
§ 1371(b) was reincorporated in another state through the corporation’s shareholders
organizing a new corporation in another state and merging the existing corporation into
the new corporation. The revenue ruling states that the surviving corporation also met
the requirements for qualification as a small business corporation.

                                   Conclusions

Based solely on the facts submitted and representations made, we conclude that X’s
election to treat Sub as a QSub on Date 4 was ineffective. We also conclude that the
circumstances resulting in the ineffectiveness of the QSub election were inadvertent
within the meaning of § 1362(f). Therefore, under the provisions of § 1362(f), Sub will
be treated as a QSub effective on Date 4, provided that Sub’s QSub election was
otherwise valid and not otherwise terminated under § 1361(b)(3)(C).

Except as expressly provided herein, we express or imply no opinion concerning the
Federal tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, we express or imply no opinion on whether X was
PLR-117184-20 4

otherwise eligible to be treated as an S corporation or whether Sub was otherwise
eligible to be treated as a QSub. Further, we express or imply no opinion on the validity
of the reorganization under §368(a)(1)(F) or the merger occurring on Date 5 and tax
consequences from either transaction.

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.

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

Pursuant to a power of attorney on file with this office, we are sending a copy of this
letter to your authorized representatives.

                                   Sincerely,


                                   ______________________________
                                   Wendy L. Kribell
                                   Senior Technician Reviewer, Branch 3
                                   Office of Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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

cc: