LLC received inadvertent S corporation election relief

Plain-English summary

An LLC's operating agreement gave owners nonidentical distribution and liquidation rights, creating a second class of stock that made its S corporation election ineffective. The LLC also made disproportionate distributions in three years that independently would have terminated an effective election, and a later reorganization otherwise ended the election. The LLC represented that the defects were inadvertent, not tax-motivated, and that it and its shareholders had consistently filed as an S corporation. The IRS granted Section 1362(f) relief, treating the LLC as an S corporation from the intended election date through the reorganization date, assuming the election was otherwise valid. Relief requires corrective distributions eliminating the cumulative disproportionate amounts and all required open-year returns or amended returns within 120 days. The ruling did not address eligibility apart from the identified defects or the reorganization's tax consequences.

Ruling snapshot

• Question: Were the ineffective S election and later termination caused by nonidentical ownership rights and disproportionate distributions inadvertent under Section 1362(f)?
• Outcome: approved, with conditions
• Key authorities: IRC §§ 1361(b)(1)(D), 1362(a), 1362(d), 1362(f); Treas. Reg. § 1.1361-1(l)

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202416005                                              Third Party Communication: None
 Release Date: 4/19/2024                                        Date of Communication: Not Applicable
 Index Number: 1362.00-00, 1362.02-00,
               1362.04-00                                       Person To Contact:
                                                                --------------, ID No. -----------------
 ----------------------------------                             Telephone Number:
 --------------------------------------------------------       --------------------
 -------------------------------------------                    Refer Reply To:
 ----------------------                                         CC:PSI:B03
 ---------------------------------                              PLR-114424-23
                                                                Date:
                                                                January 17, 2024




LEGEND

X                 =        --------------------------
--------------------------------------------------
A                 =        --------------------
B                 =        -----------------------
C                 =        -------------------------------------------------------
D                 =        ------------------------------------------------------
E                 =        ----------------------
F                 =        ----------------------
State             =        --------
Date 1            =        --------------------------
Date 2            =        ---------------------
Date 3            =        ----------------------
Date 4            =        -----------------------
Agreement 1 =              ----------------------------------------------------------
Year 1            =        -------
Year 2            =        -------
Year 3            =        -------
Year 4            =        -------
PLR-114424-23                                 2


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

        This letter responds to a letter dated June 8, 2023, and subsequent
correspondence, submitted on behalf of X by X’s authorized representatives, requesting
relief under § 1362(f) of the Internal Revenue Code (Code).

                                          FACTS

      According to the information submitted, X was organized as a limited liability
company under the laws of State on Date 1. X elected to be treated as an S
corporation pursuant to § 1362(a) effective Date 3. X represents that on and after Date
3 and until Date 4, the owners of X were eligible S corporation shareholders.

       Agreement 1, X’s operating agreement effective Date 2, did not provide for
identical rights to distribution and liquidation proceeds which caused X to have more
than one class of stock under § 1361(b)(1)(D), and therefore X’s S corporation election
made on Date 3 was ineffective. X also made disproportionate distributions to A, B, C,
D, E, and F during Year 1, Year 2, and Year 3 which would also have caused the S
election to terminate. Further, a reorganization in Year 4 otherwise caused X’s S
election to terminate.

       X represents that the circumstances surrounding the ineffectiveness of X’s S
corporation election made on Date 3 were inadvertent and not the result of tax
avoidance or retroactive tax planning. Further, X represents that X and its shareholders
have filed tax returns consistent with X being an S corporation. Finally, X and its
shareholders agree to make any adjustments that may be required by the Secretary as
a condition of obtaining relief under § 1362(f).

                                  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) of the Income Tax Regulations provides that a corporation
is generally treated as having one class of stock if all outstanding shares of stock of the
corporation confer identical rights to distribution and liquidation proceeds.
PLR-114424-23                                 3


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

      Section 1362(a)(1) provides that, except as provided in § 1362(g), a small
business corporation may elect to be an S corporation.

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

        Section 1362(f) provides, in 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 (B) was terminated under § 1362(d)(2), (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 so that the corporation for which the
election was made or the termination occurred is a small business corporation, 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 made 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 the representations made, we conclude
that X’s S corporation election was not effective when made on Date 3 because X had
more than one class of stock. We further conclude that, even if X’s S election was not
ineffective on Date 3, it would have terminated in Year 1 due to disproportionate
distributions made by X. We conclude that the circumstances that caused X’s
S election to be ineffective and subsequently terminate in Year 1 were inadvertent
within the meaning of § 1362(f). Therefore, under § 1362(f), X will be treated as an S
corporation from Date 3 to Date 4, provided that its S corporation election was
otherwise valid and has not otherwise terminated under § 1362(d).
PLR-114424-23                                 4

       This ruling is contingent on X and its shareholders taking remedial steps to make
corrective distributions to its shareholders to eliminate the cumulative amount of the
disproportionate distributions made by X to its shareholders by filing, within 120 days
from the date of this letter, all required returns (including amended returns) for all open
years consistent with X’s election to be treated as an S corporation from Date 3 to Date

4. A copy of this letter should be attached to any such returns.

       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 was
otherwise eligible to be an S corporation and any tax consequences related to the
reorganization in Year 4.

       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 request for rulings, it is subject to verification on examination.

       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.

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




                                      Sincerely,



                                      Robert Alinsky
                                      Chief, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)




Enclosure:
      Copy of this letter for § 6110 purposes
PLR-114424-23                                            5

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