S corporation keeps its status despite a nonresident-alien shareholder that made the election invalid

Plain-English summary

A small corporation elected to be taxed as an S corporation, but the election was never valid because one of its two shareholders was a nonresident alien. Under Code § 1361, an S corporation cannot have a nonresident alien as a shareholder, so the election was ineffective from day one. The company later fixed the problem so that only its U.S.-citizen shareholder held stock, and it asked the IRS for relief under § 1362(f), which lets the IRS overlook an invalid or terminated S election when the failure was inadvertent. The IRS agreed the mistake was inadvertent and not tax-motivated, so it will treat the company as an S corporation from the original effective date forward. The relief is conditional: the company must treat the U.S.-citizen shareholder as having owned the nonresident alien's shares from the start, and both must file all required returns (including amended returns) consistent with that treatment within 120 days. This matters because it lets the corporation and its shareholders avoid the harsh tax consequences of an accidental S-election failure.

Ruling snapshot

• Question: Was the corporation's ineffective S election (caused by a nonresident-alien shareholder) an inadvertent failure that qualifies for relief under § 1362(f)?
• Outcome: approved (S status preserved from the original effective date, conditioned on consistent share treatment and return filings)
• Key authorities: IRC §§ 1361(b), 1362(f); Treas. Reg. § 1.1361-1(g)(1)(i)

Full text (IRS public release)

 Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202430002                                            Third Party Communication: None
 Release Date: 7/26/2024                                      Date of Communication: Not Applicable
 Index Numbers: 1361.00-00, 1361.01-03,
                1362.00-00, 1362.04-00                        Person To Contact:
                                                              ------------------------, ID No. ------------------
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 ---------------------------------------                      Telephone Number:
 -------------------                                          --------------------
 ----------------------------                                 Refer Reply To:
 ----------------------------------------                     CC:PSI:B03
                                                              PLR-121543-23
                                                              Date:
                                                              April 23, 2024


LEGEND

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

 Date1 = ------------------

 Date2 = ----------------

 Date3 = ---------------------

 A         = ---------------------------------------------------------------------------------------------------
             --------------------------

 B         = ---------------------------------------------------------------------------------------------------
             ------------------------

 State     = --------


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

        This letter responds to a letter dated October 12, 2023, and subsequent
correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under § 1362(f) of the Internal Revenue Code (Code).
PLR-121543-23                                2

                                         FACTS

       According to the information submitted, X, a State corporation, elected to be an S
corporation effective Date 1. As of Date 1, X had two shareholders, A, a U.S. citizen,
and B, a nonresident alien. In Date 2, X learned that its S corporation election was
ineffective because B was an ineligible S corporation shareholder. Subsequently, X and
its shareholders took remedial steps so that as of Date 3, only A held shares of X stock.

       X represents that the circumstances resulting in its ineffective S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. Additionally, X represents that it has filed its federal tax returns consistent
with being an S corporation effective Date 1. Finally, X and its shareholders agree to
make any adjustments (consistent with the treatment of X as an S corporation) as may
be required by the Secretary.

                                  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 such 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(g)(1)(i) provides, in part, that a corporation having a
shareholder who is a nonresident alien as defined in § 7701(b)(1)(B) does not qualify as
a small business corporation.

      Section 1362(a) provides that a small business corporation may elect to be an S
corporation.

        Section 1362(d)(2)(A) provides that an election under § 1362(a) is terminated
whenever (at any time on or after the first day of the first taxable year for which the
corporation is an S corporation) the corporation ceases to be a small business
corporation. Section 1362(d)(2)(B) provides that any termination under § 1362(d)(2) is
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 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); (2) the Secretary determines that the circumstances resulting in the
PLR-121543-23                                3

ineffectiveness were inadvertent; (3) no later than a reasonable period of time after
discovery of the circumstances resulting in the ineffectiveness, steps were taken so that
the corporation for which the election was made is a small business corporation; and
(4) the corporation for which the election was made, and each person who was a
shareholder of the corporation at any time during the period specified under § 1362(f),
agrees to make the adjustments (consistent with the treatment of the corporation as an
S corporation) as may be required by the Secretary for that period, then,
notwithstanding the circumstances resulting in such ineffectiveness, 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’s S corporation election was ineffective on Date 1 because, on Date 1, X had an
ineligible shareholder under § 1361(b)(1)(C). We conclude, however, that the
circumstances resulting in the ineffectiveness were inadvertent within the meaning of
§ 1362(f). Therefore, under § 1362(f), X will be treated as an S corporation from Date 1
and thereafter, provided that X’s S corporation election was valid and has not otherwise
terminated under § 1362(d).

       This ruling is contingent on X treating A as owning the shares of X stock
previously held by B from Date 1 and thereafter, and X and A filing within 120 days from
the date of this letter all required returns (including amended returns) for all open years
consistent with A owning all the shares of X stock since Date 1.

       Except as specifically ruled upon 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 and the regulations thereunder. Specifically, we express or imply
no opinion regarding whether X is otherwise eligible to be an S corporation.

       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 requested ruling, 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 it may not be used or cited as precedent.
PLR-121543-23                                            4

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

                                                Sincerely,



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


Enclosure:
      Copy of this letter for § 6110 purposes

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