S corporation status restored after stock was transferred to an IRA

Plain-English summary

A company taxed as an S corporation transferred some of its shares into an individual retirement account (IRA) set up for one person. An IRA is not an allowed S corporation shareholder, so the transfer automatically ended the company's S election. Neither the company nor its owners realized this would happen. Once they learned of the problem, they redeemed (bought back) the shares held in the IRA for cash. The company asked the IRS to treat the loss of S status as inadvertent under § 1362(f). The IRS agreed the termination was inadvertent and ruled that the company will be treated as an S corporation continuously from the date of the improper transfer, as long as its election was otherwise valid. This matters because holding S corporation stock in a retirement account or other ineligible hands silently breaks S status; § 1362(f) lets a company undo an honest mistake and avoid corporate-level tax.

Ruling snapshot

• Question: Was the termination of the company's S corporation election, caused by transferring stock to an ineligible IRA shareholder, inadvertent under § 1362(f)?
• Outcome: approved (relief granted; treated as an S corporation without interruption)
• Key authorities: IRC § 1362(f); IRC § 1361(b)(1)(B); Rev. Rul. 92-73

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202310008                                             Third Party Communication: None
 Release Date: 3/10/2023                                       Date of Communication: Not Applicable
 Index Number: 1362.00-00, 1362.04-00
                                                               Person To Contact:
 -----------------------------------                           ------------------------, ID No. -----------------
 ------------------------------------------------              Telephone Number:
 ------------------------------                                --------------------
 ---------------------                                         Refer Reply To:
 ----------------------------------                            CC:PSI:B01
                                                               PLR-118266-22
          RE: ----------------------------------------------   Date:
 ------                                                        December 13, 2022




Legend

 X     = ----------------------------------------------------------------------------------------------------
         -----------------------
 Y     = ----------------------------------------------------------------------------------------------------
         -----------------------
 D1    = --------------------
 D2    = ----------------------
 D3    = ----------------------
 a     = -----
 b     = ------------
 State = ------------------

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

This responds to your letter, dated September 12, 2022, and subsequent
correspondence, submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code.

                                                    FACTS

The information submitted states that X was formed as a limited liability company in
State and made an election to be treated as an S corporation effective D1. On D2, X
transferred a shares to an individual retirement account (IRA) created for the benefit of
Y in exchange for b. An IRA is not an eligible shareholder of an S corporation under §
1361(b)(1)(B). Neither X nor X’s shareholders were aware that the transfer of stock to
Y’s IRA would cause X’s S corporation election to terminate.
PLR-118266-22                                 2

Once X learned of the termination of X’s S corporation election due to the transfer of
stock to an ineligible shareholder, X redeemed the shares issued to Y’s IRA for cash on
D3.

X represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. X represents that it filed consistent with treatment of X as an S corporation
from D2 to D3. X and its shareholders have agreed to make such adjustments
(consistent with such treatment as an S corporation) as may be required by the
Secretary.

                                           LAW

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 such year.

Section 1361(b)(1)(B) provides that the term “small business corporation” means a
domestic corporation which is not an ineligible corporation and which does not 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.

Section 1362(d)(2)(A) provides that in general, 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) provides that any termination under §
1362(d)(2)(A) is effective on and after the date of cessation.

Rev. Rul. 92-73, 1992-2 C.B. 224, provides that a trust that qualifies as an IRA under §
408(a) is not a permitted shareholder of an S corporation under § 1361. In addition,
Rev. Rul. 92-73 notes that, when an S corporation inadvertently terminates due to the
transfer of S corporation stock to an IRA, relief may be requested pursuant to § 1362(f).

Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation 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 was terminated under § 1362(d)(2), (2) the Secretary
determines that the circumstances resulting in such ineffectiveness or termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in such ineffectiveness or termination, steps were taken so that
the corporation for which the election was made or the termination occurred is a small
business corporation or to acquire the required shareholder consents, and (4) the
corporation for which the election was made or the termination occurred, and each
person who was a shareholder in such corporation at any time during the period
specified pursuant to § 1362(f), agrees to make the adjustments (consistent with the
treatment of such corporation as an S corporation) as may be required by the Secretary
PLR-118266-22                                3

with respect to such period, then, notwithstanding the circumstances resulting in such
ineffectiveness or termination, such corporation shall 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’s S
corporation election terminated on D2 when shares of X’s stock were transferred to Y’s
IRA, an ineligible S corporation shareholder. We conclude, however, that the
termination described in this paragraph was inadvertent within the meaning of § 1362(f).
Therefore, X will be treated as an S corporation effective D2 and thereafter, provided
that its S corporation election was otherwise valid and has not terminated under §
1362(d) other than as discussed in this letter.

Except for the specific ruling above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. In particular, we express or imply no opinion regarding X’s eligibility to be an S
corporation.

The ruling contained in this letter is based on information and representations submitted
by the taxpayer and accompanied by a penalty of perjury statement executed by the
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 requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

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


                                      Sincerely,


                                      ________________________________________
                                      Laura Fields, Chief
                                      Branch 1
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)



Encl:
        Copy for § 6110 purposes

cc: