IRS grants late S corporation election relief and forgives two inadvertent terminations

Plain-English summary

A corporation meant to be an S corporation from its first day, but it never filed its Form 2553 election on time. Two other problems also surfaced. First, a shareholder's spouse, a nonresident alien, was treated as owning part of the stock under a foreign community-property regime; because an S corporation cannot have a nonresident alien shareholder, this would have terminated the election, so the spouse transferred her interest to her husband. Second, a stock-purchase agreement contained an anti-dilution provision that gave one shareholder special rights, which counted as a prohibited second class of stock; the company later removed that provision. Throughout, the company and its shareholders had filed their returns as if the S election was valid. The IRS ruled that the company had reasonable cause for the late election, so it will be treated as timely if the company files Form 2553 within 120 days, and that both would-be terminations (the nonresident alien shareholder and the second class of stock) were inadvertent under section 1362(f). As a result, the company is treated as continuing to be an S corporation.

Ruling snapshot

• Question: Can the company obtain relief for its late S corporation election and be treated as continuing to be an S corporation despite a nonresident-alien shareholder and a second class of stock?
• Outcome: Approved (late-election relief under § 1362(b)(5) if Form 2553 is filed within 120 days; both terminations ruled inadvertent under § 1362(f))
• Key authorities: IRC §§ 1362(b)(5), 1362(f); IRC § 1361(b)(1); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202149004 Third Party Communication: None
Release Date: 12/10/2021 Date of Communication: Not Applicable
Index Numbers: 1362.01-03, 1362.04-00
Person To Contact:
---------- -----------------, ID No. -----------------
--------------------------------------- Telephone Number:
------------------------------------------------ ---------------------
------------------------------ Refer Reply To:
-------------------------- CC:PSI:03
PLR-106516-21
Date:
September 15, 2021

Legend:

X: = -----------------------------------------
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A: = -------------------------
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B: = -------------------------------------------

C: = ---------------------
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State = ------------

Country: = ----------

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

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

Date 3: = -----------------------
PLR-106516-21 2

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

   This letter responds to a letter dated March 3, 2021, and subsequent

correspondence submitted on behalf of X by its authorized representatives requesting
rulings under §§ 1362(b)(5) and 1362(f) of the Internal Revenue Code (Code).

                                     FACTS

   The information submitted states that X was incorporated on Date 1 under the

laws of State. X intended to be an S corporation effective Date 1. However, X’s Form
2553, Election by a Small Business Corporation, was not timely filed.

   On Date 2, A, a U.S. citizen, acquired shares of stock in X. At that time, A was

(and is still) married to B, a citizen and resident of Country. Country is a community
property jurisdiction such that B is considered to own an interest in the stock of X on
Date 2. As a citizen of Country who is not residing in the U.S., B, a nonresident alien,
was an ineligible S corporation shareholder. Consequently, had X’s S corporation
election been effective Date 1, it would have terminated on Date 2. Upon discovering
that X had an ineligible S corporation shareholder, B signed an agreement transferring
her interest in the stock of X to A.

    On Date 3, X entered into an agreement with C, a shareholder in X, to purchase

additional shares of stock in X. The agreement contained an anti-dilution provision with
respect to C’s shares in X such that C would maintain a fixed ownership percentage in
X. X represents that the agreement is a governing provision within the meaning of
§ 1.1361-1(l)(2)(i) of the Income Tax Regulations and that the effect of the anti-dilution
provision in the agreement caused X to have more than one class of stock.
Consequently, had X’s S corporation election been effective Date 1, it would have
terminated on Date 3. Upon learning that it had more than one class of stock, X
amended the agreement with C pursuant to which the anti-dilution provision was
stricken, and B’s ownership interest was adjusted to exclude the application of the anti-
dilution provision.

   X states that X and its shareholders have filed their federal income tax returns

consistent with X having a valid S corporation election in effect as of Date 1. X
represents that the circumstances resulting in the termination of its S corporation
election under § 1362(f) were inadvertent and not motivated by tax avoidance or
retroactive tax planning. X and its shareholders have agreed to make adjustments
consistent with the treatment of X as an S corporation as may be required by the
Secretary.
PLR-106516-21 3

                                  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
one class of stock.

   Section 1.1361-1(l)(1) provides, in part, 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.

   Section 1.1361-1(l)(2)(i) provides 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 law, and binding agreements relating to distribution and liquidation
proceeds (collectively, the governing provisions).

    Section 1362(b)(1) provides that an election under § 1362(a) may be made by a

small business corporation for any taxable year (A) at any time during the preceding
taxable year, or (B) at any time during the taxable year and on or before the 15th day of
the third month of the taxable year.

   Section 1362(b)(3) provides that if (A) a small business corporation makes an

election under § 1362(a) for any taxable year and (B) the election is made after the 15th
day of the third month of the taxable year and on or before the 15th day of the third
month of the following taxable year, then such election shall be treated as made for the
following taxable year.

   Section 1362(b)(5) provides that if (A) an election under § 1362(a) is made for

any taxable year (determined without regard to § 1362(b)(3)), after the date prescribed
by § 1362(b) for making such election for such taxable year or no § 1362(a) election is
made for any taxable year, and (B) the Secretary determines that there was reasonable
cause for the failure to timely make the election, the Secretary may treat such an
election as timely made for the taxable year (and § 1362(b)(3) shall not apply).

   Section 1362(d)(2)(A) provides than 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
PLR-106516-21 4

business corporation. Section 1362(d)(2)(B) further provides that the termination shall
be effective on and after the date of cessation.

    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) or to obtain shareholder consents or (B) was terminated
under § 1362(d)(2) or (3); (2) the Secretary determines that the circumstances resulting
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 (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) 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 during the period specified by the Secretary.

                                     CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

X has established reasonable cause for failing to make a timely election to be an
S corporation effective Date 1. Thus, we conclude that X is eligible for relief under
§ 1362(b)(5). Accordingly, if X makes an election to be an S corporation by filing a
completed Form 2553 with the appropriate service center effective Date 1, within 120
days from the date of this letter, then such election will be treated as timely made. A
copy of this letter should be attached to the Form 2553 filed with the service center.

   In addition, we conclude that had X’s S corporation election been effective

Date 1, it would have terminated on Date 2 when X had an ineligible S corporation
shareholder. Also, we conclude that had X’s S corporation election not terminated on
Date 2, it would have terminated on Date 3 as a result of X having more than one class
of stock. We further conclude that the circumstances resulting in the terminations on
Date 2 and Date 3 were inadvertent within the meaning of § 1362(f). Thus, X will be
treated as continuing to be an S corporation from Date 2 and thereafter, provided X’s S
corporation election is otherwise valid and 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, we express or imply no opinion on whether X is
otherwise eligible to be treated as an S corporation.
PLR-106516-21 5

  These rulings are directed only to the taxpayer that requested it. Section

6110(k)(3) of the Code provides that the rulings may not be used or cited as precedent.

  The rulings contained in this letter are 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 rulings requested, it is subject to verification on
examination.

    Pursuant to a power of attorney on file with this office, we are sending a copy of

this letter to your authorized representatives.

                                  Sincerely,




                                   Mary Beth Carchia
                                   Senior Technician Reviewer, Branch 3
                                   Office of Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosure
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