IRS lets an entity change its tax classification to a partnership inside the normal 60-month lock-out after an ownership change

Plain-English summary

When a business entity elects to change how it is taxed (its "check-the-box" classification), it normally cannot elect to change again for 60 months. There is an exception: the IRS may allow an earlier change if more than 50% of the entity's ownership at the time of the new election is held by people who did not own it when the prior election took effect. Here an LLC had elected to be an S corporation (which is treated as a deemed election to be taxed as a corporation), was later contributed to a new holding company and treated as a qualified subchapter S subsidiary, and then had a new owner acquire more than half of it. The entity asked to switch its classification to a partnership before the 60 months were up. Because the ownership had turned over by more than 50%, the IRS consented to the change effective the day after the ownership shift, and gave the entity 120 days to file Form 8832 to make it happen, conditioned on filing consistent returns. The IRS expressed no opinion on whether the entity is otherwise eligible to make the election. This is a narrow entity-classification consent, not a broad ruling on the transaction.

Ruling snapshot

• Question: May an entity change its check-the-box classification to a partnership within the 60-month lock-out period because more than 50% of its ownership changed after the prior election?
• Outcome: Approved (consent granted; 120 days to file Form 8832)
• Key authorities: Treas. Reg. § 301.7701-3(c)(1)(iv), (b), (c)(1)(v)(C); IRC § 1361(b)(3) (QSub); IRC § 1362(a)

Full text (IRS public release)

 Internal Revenue Service                                        Department of the Treasury
                                                                 Washington, DC 20224

 Number: 202332005                                               Third Party Communication: None
 Release Date: 8/11/2023                                         Date of Communication: Not Applicable

 Index Number: 7701.00-00                                        Person To Contact:
                                                                 ----------------------, ID No. -----------------
 -------------------------------------------------------         Telephone Number:
 ------------------------------------                            --------------------
 ---------------------------------------------------             Refer Reply To:
 --------------------------                                      CC:PSI:B01
 ------------------------------                                  PLR-122197-22
  --------------------------------                               Date:
                                                                 May 10, 2023




Legend

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

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

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

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

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

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

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

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

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


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

This letter responds to a letter dated November 7, 2022, submitted on behalf of X,
requesting a ruling under § 301.7701-3(c)(1)(iv) of the Procedure and Administration
Regulations.

                                                       FACTS
PLR-122197-22                                  2

The information submitted states that X was formed under the laws of State as a limited
liability company on Date 1. X subsequently elected to be an S corporation effective
Date 2. Under § 301.7701-3(c)(1)(v)(C), X is treated as having made an election to be
classified as an association taxable as a corporation for federal tax purposes effective
Date 2. On Date 3, the owners of X formed Y, and on Date 4, the owners of X
contributed all outstanding X shares to Y. As a result of the transaction, Y was treated
as an S corporation and subsequently made an election for X to be treated as a
Qualified Subchapter S Subsidiary (QSub) pursuant to § 1361(b)(3). On Date 5, a new
owner acquired more than fifty percent of X.

                                   LAW AND ANALYSIS

Section 1361(b)(3)(A) of the Internal Revenue Code provides that a QSub shall not be
treated as a separate corporation, and 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) defines a QSub as a domestic corporation which is not an
ineligible corporation as defined in § 1361(b)(2), if 100 percent of the stock of the
corporation is held by an S corporation, and the S corporation elects to treat the
corporation as a QSub.

Section 1.1361-3(a) of the Income Tax Regulations provides the time and manner of
making a QSub election. Section 1.1361-3(a)(2) provides that an S corporation makes a
QSub election with respect to a subsidiary by filing a Form 8869 with the appropriate
service center. Section 1.1361-3(a)(4) provides that a QSub election cannot be effective
more than two months and 15 days prior to the date of filing.

Section 301.7701-3(a) provides that a business entity that is not classified as a
corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7) or (8) (an eligible entity) can
elect its classification for federal tax purposes as provided in § 301.7701-3. Elections
are necessary only when an eligible entity does not want to be classified under the
default classification or when an eligible entity chooses to change its classification.

Section 301.7701-3(b)(1) provides that, unless the entity elects otherwise, a domestic
eligible entity is (i) a partnership if it has two or more members; or (ii) disregarded as an
entity separate from its owner if it has a single owner.

Section 301.7701-3(c)(1)(i) provides that, except as provided in § 301.7701-3(c)(1)(iv)
and (v), an eligible entity may elect to be classified other than as provided under
§ 301.7701-3(b), or to change its classification, by filing Form 8832, Entity Classification
Election, with the service center designated on Form 8832.

Section 301.7701-3(c)(1)(iii) provides that an election made under § 301.7701-3(c)(1)(i)
will be effective on the date specified by the entity on the Form 8832 or on the date filed
PLR-122197-22                                  3

if no date is specified on the election form. The effective date specified on Form 8832
cannot be more than 75 days prior to the date on which the election is filed and cannot
be more than 12 months after the date on which the election is filed.

Section 301.7701-3(c)(1)(iv) provides that, if an eligible entity makes an election under
§ 301.7701-3(c)(1)(i) to change its classification, the entity cannot change its
classification by election again during the sixty months succeeding the effective date of
the election. However, the Commissioner may permit the entity to change its
classification by election within the sixty months if more than fifty percent of the
ownership interests in the entity as of the effective date of the subsequent election are
owned by persons that did not own any interests in the entity on the filing date or on the
effective date of the entity’s prior election.

Section 301.7701-3(c)(1)(v)(C) provides that an eligible entity that timely elects to be an
S corporation under § 1362(a)(1) is treated as having made an election under §
301.7701-3 to be classified as an association, provided that (as of the effective date of
the election under § 1362(a)(1)) the entity meets all other requirements to qualify as a
small business corporation under § 1361(b). Subject to § 301.7701-3(c)(1)(iv), the
deemed election to be classified as an association will apply as of the effective date of
the S corporation election and will remain in effect until the entity makes a valid election,
under § 301.7701-3(c)(1)(i), to be classified as other than an association.

                                      CONCLUSION

Based solely on the information submitted and the representations made, we consent to
X changing its entity classification to a partnership for federal tax purposes effective
Date 6, the day immediately after Date 5, under § 301.7701-3(c)(1)(iv). As a result, X is
granted an extension of time of 120 days from the date of this letter to file Form 8832
with the appropriate service center to elect to be classified as a partnership for federal
tax purposes, effective Date 6. A copy of this letter should be attached to the Form
8832.

This ruling is contingent on X and its owner filing, within 120 days from the date of this
letter, any required returns (including amended returns) consistent with the requested
relief being effective on Date 6. A copy of this letter should be attached to any such
returns or amended returns. If this condition is not met, then this ruling is null and void.
A copy of this letter should be attached to any such returns.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, we express or imply no opinion regarding whether X is otherwise
eligible to make the election.

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
PLR-122197-22                                4

by an appropriate party. While this office has not verified any of the material submitted
in support of the request for ruling, 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 the power of attorney on file with this office, we are sending a copy
of this letter to X’s authorized representative.


                                      Sincerely,



                                      Joy C. Spies
                                      Senior Technician Reviewer, Branch 1
                                      (Passthroughs & Special Industries)



Enclosure
      Copy for § 6110 purposes



cc: