IRS written determination 201430011

Private letter rulings and published taxpayer determination letters. Native document type is retained separately; a determination letter is not labeled a private letter ruling. These taxpayer-specific releases cannot be used or cited as precedent under 26 USC 6110(k)(3); applicability and current legal force are not independently certified. Keep repeated UILC subjects attached to one actual numbered document.

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 201430011
Release Date: 7/25/2014
Index Number: 1362.04-00
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Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact:
-------------, ID No. ----------------
Telephone Number:
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Refer Reply To:
CC:PSI:B02
PLR-148385-13
Date:
December 20, 2013
LEGEND
Company=-------------------------
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Sub 1=-----------------
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Sub 2=------------------------------------------
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State=----------
Date 1=-----------------
Date 2=-----------------------
Date 3=----------------
Date 4=--------------------------
Date 5=------------------
Date 6=---------------------
Year 1=------

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Year 2=------
Year 3=------
Dear ----------------:
This letter is in response to your request, dated November 25, 2013, on behalf of
Company, seeking relief under § 1362(f) of the Internal Revenue Code.
FACTS
Based onthe materials submitted and representations within, we understand the
relevant facts to be as follows: Companyis a domestic corporation organized under the
laws of Stateon Date 1. Three individuals collectively owned all of Company’s
outstanding common stock.
Sub 1is a domestic corporation organized under the laws of Stateon Date 2. Sub 1’s
charter authorized 100 shares of common stock. Effective Date 3, Sub 1’s articles were
amended to authorize two classes of common stock: 8,000 shares of voting Class A
common stock and 2,000 shares of Class B common stock, with the Class B stock
being identical to the Class A stock except for the fact that the Class B stock was
nonvoting. The same three individuals that owned Companyowned all of Sub 1’s
outstanding Class A shares. Companyhas been unable to locate the stock record book
for Sub 1following the death of one of the founding shareholders who served as
primary record keeper, but Companybelieves no Class B common shares were issued.
Effective onDate 4, the Company’s articles of incorporation were amended to create
two classes of common stock, identified as “Class A Common Stock” and “Class B
Common Stock,” and all outstanding shares of the Original Common Stock were
converted into an equal number of shares of Class A Common Stock. On Date 4, or
shortly thereafter, the owners of Sub 1contributed all of their respective shares of Sub 1
to Companyin exchange for a total of 1,000 newly issued shares of Class B Common
Stock with the intention of having Companyown all of the equity interests in Sub 1.
Following the Date 4contribution, Companybelieves that it acquired, and continues to
own as of the date of this letter, 100% of Sub 1’s outstanding shares.
On Date 5, subsequent to the contribution of Sub 1to Company, compensatory options
to acquire shares of Class B Common Stock of Sub 1were granted to an employee,
exercisable only upon a change in control of Sub 1. The provision of the employee’s
Employment Agreement which provided for the issuance of the options states that the
options were “for the purchase of shares of Class B Non-Voting Common Stock ...equal
to, as of the date hereof, eight percent (8%) of the outstanding Class B Common Stock
of [Sub 1].” Companyrepresents that those options were never exercised and were

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later exchanged by the employee for options to acquire shares of Company. Company
represents that, as of the date of this letter, that no persons have ever come forward
and asserted rights as a holder of outstanding Class B shares of Sub 1.
In the months leading up to Date 6, Companyengaged outside tax advisors to consider
an S corporation election for Companyand a QSub election for Sub 1. In order to
satisfy the single class of stock requirement, the Companydeterminedthat it would
redeem all of the outstanding shares of Class A Common Stock in exchange for a
distribution, to be made by Companyto the shareholders on a pro rata basis (the
Redemption Transaction), of Sub 2described below. In addition, Company’s tax
advisors recommended amending Company’s articles of incorporation to convert the
Class B Common Stock, the only remaining class of stock that would be outstanding
following the Redemption Transaction, to a single class of ordinary common stock.
Company filed a timely election under § 1362(a) to be treated as an S corporation
effective beginning on Date 6. Company timely filed Form 8869, Qualified Subchapter
S Subsidiary Election, for Sub 1, also effective Date 6. Company, however, has no
record of executing the Redemption Transaction or subsequent recapitalization before
Date 6. Several months after Date 6, the shareholders signed the documents relating to
the Redemption Transaction and recapitalization and the recapitalization became
effective on the date it was filed with State’s Secretary of State, however the documents
provided that the transaction’s effective date related back to the date immediately prior
to Date 6.
At the same time Companyelected to be treated as an S corporation, Sub 2filed a
timely election under § 1362(a) to be treated as an S corporation effective beginning on
Date 6. However, due to an oversight by Company’s tax preparers, beginning in the
first year of the S corporation election and the following three taxable years, Sub 2
reported all income, gain, loss, deduction, and credits as if it was a QSub of Company.
Beginning with the fifth taxable year after Date 6, Sub 2began filing tax returns as a
separate S corporation.
In the years following Date 6, Companywould make pro rata cash distributions to its
stockholders. Companyrecorded the distributions as debits to separate Distribution
Accounts maintained for each shareholder. The Distribution Accounts were similar to
draw accounts or a contra account to stockholder’s equity, and they were closed out
annually to stockholder’s equity. Periodically, however, Companywould make
payments on behalf of a shareholder that were also charged to the shareholder’s
Distribution Account. As a result of the non pro rata debits to theDistribution Accounts,
at year-end the shareholders’ respective account balances were not in proportion to
their respective percentage ownership of Company. Accordingly, to bring each
shareholder’s Distribution Account balances into alignment with their percentage
interests in Company, Companywould determine a target balance for each
shareholder’s Distribution Account. Companythen made adjusting entries on their

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books so as to cause each shareholder’s Distribution Account balance to equal that
target balance. Companyreported the final post-adjustment Distribution Account
balances as distributions for all relevant tax purposes. The shareholder receivables and
payables were evidenced only by book entries. Companydid not charge or receive
interest on the loan balances. The loan balances were not required to be settled up by
a specified time following year-end, but instead were allowed to remain outstanding,
with the balances fluctuating from year to year.
In Year 1, one of the shareholders died. In December of Year 2, the other two founding
shareholders purchased all of the shares of Companythen owned by that shareholder’s
estate and his surviving spouse pursuant to a Purchase Agreement. Section 3(a) of the
Purchase Agreement provided for a pre-closing distribution by Company. Specifically, it
recited that Companywill make a pro rata tax free distribution in the same number of
dollars per share. Section 3(a) also provided that Companywould pay a specified dollar
amount of the aggregate distribution to the estate and surviving spouse at the closing.
Companymade a distribution in December of Year 2to the two acquiring shareholders
which they used to finance a portion of the buyout purchase price. An additional
distribution was made to each ofacquiring shareholders on the closing date of the
buyout, which were also applied by them to finance the buyout. Between amounts paid
by the two shareholders at closing and the amounts distributed by Company, the estate
and surviving spouse received the purchase price contemplated by the Purchase
Agreement. Although the cash distribution records indicate disproportionate
distributions, Companytax return reporting for Year 2show aggregate distributions to
shareholders allocated among them in proportion to their respective stockholdings
during the year. Thus, Companybelieves that a portion of the amounts distributed to
the two acquiring shareholders represented distributions to the estate and surviving
spouse, and the estate and surviving spouse ended up receiving such amounts, so that
the Year 2tax reporting accurately reflects the ultimate economics of the Purchase
Agreement. Following the buyout, Companydetermined that it was only necessary to
equalize the distributions of the two remaining, and now equal, shareholders because
the estate and surviving spouse were bought out at year-end. Thus, when the books
were closed, Companymade adjusting entries to the two remaining shareholders
Distribution Account balances, while the surviving spouse’s Distribution Account
balance was left unadjusted.
In Year 3, Companyagreed to sell the stockof Sub 1to an unrelated third-party. As
part of the buyer’s due diligence, the buyer notified company that the QSub election
may havebeen ineffective because (i) the Companymay have had an invalid S election
as a result of having two classes of stock outstanding if the Redemption Transaction
was not effective retroactively or as a result of the distributions described above, and (ii)
if any outstanding Class B Non-Voting Common Stock had been issued as a result of
the exercise of the employee stock option or otherwise, the Companymay not have
been the sole shareholder of Sub 1. To correct any potential issue in this regard, Sub 1
completed a recapitalization in which Sub 1issued 1,000 Class B shares to Company.

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Following the issuance of the Class B Shares, Sub 1completed a reverse stock split of
both the Class A shares (7500:1) and Class B shares (2000:1). The amendment to the
articles memorializing the reversestock split also provided that any fractional shares of
Class B stock resulting from the reverse stock split were converted into a right to
receive cash. Thus, the recapitalization eliminated any possibility that any person other
than the Companyowns shares of Sub 1stock, and any unknown holder would simply
have a right to assert a claim for damages but not the rights of a stockholder.
Also in Year 3, the Distribution Account loan balances were paid in full, with cash
payments being made by Companyor by the shareholders, as applicable, to discharge
the then outstanding due to/due from balances.
RULINGS REQUESTED
Companyrequest rulings to the effect that:
(1) If Company’s S election was invalid, it was an inadvertent invalid election
within the meaning of § 1362(f) and, therefore, Companywill be treated as an S
corporation commencing with its taxable year beginning Date 6and continuing
thereafter, provided that the Company’s S corporation election is otherwise valid and is
not otherwise terminatedunder § 1362(d). In addition, to the extent the manner in
which Companymade distributions and advances to its shareholders created a second
class of stock, the termination of Company’s S election was inadvertent under § 1362(f)
and, therefore, the Company will be treated as an S corporation commencing with its
taxable year beginning Date 6and continuing thereafter, provided that the Company’s S
corporation election is otherwise valid and is not otherwise terminated under § 1362(d).
(2) Sub 1’s QSub election, to the extent it was otherwise invalid or terminated
because Company’s S election was invalid or subsequently terminated, or because of
the possibility that Sub 1may have had unidentified shareholders other than Company
on or after Date 6, should likewise be treated as an inadvertent invalid election or an
inadvertent termination of such election within the meaning of § 1362(f) and, therefore,
Sub 1will be treated as a QSub of Companyeffective as of Date 6and continuing
thereafter, provided that Sub 1’s QSub election is otherwise valid and is not otherwise
terminated under § 1361(b)(3)(C).
In accordance with § 1362(f) and § 1.1362-4, Companyand each person who has been
a shareholder of Companyat any time after Date 6through the date of the ruling
request have consented to any adjustments as may be required by the Secretary.
Company, Sub 1, and Company’s shareholders represents that the tax returns for all of
the relevant tax years since Date 6are not inconsistent with the tax treatment of
Companyas an S corporation, and Sub 1as a QSub.
LAW AND ANALYSIS

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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)(D) provides that, for purposes of subchapter S, the term “small
business corporation” means a domestic corporation that is not an ineligible corporation
and that does not, among other things, have more than one class of stock.
Section 1.1361-1(I)(1) of the Income Tax Regulations provides 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(I)(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”). A commercial contractual agreement, such as a lease,
employment agreement, or loan agreement, is not a binding agreement relating to
distribution and liquidation proceeds and thus is not a governing provision unless a
principal purpose of the agreement is to circumvent the one class of stock requirement.
Although a corporation is not treated as having more than one class of stock so long as
the governing provisions provide for identical distribution and liquidation rights, any
distributions (including actual, constructive, or deemed distributions) that differ in timing
or amount are to be given appropriate tax effect in accordance with the facts and
circumstances.
Section 1.1361-1(I)(2)(iii)(B) provides that bona fide agreements to redeem or purchase
stock at the time of death, divorce, disability, or termination of employment are
disregarded in determining whether a corporation’s shares of stock confer identical
rights.
Section 1361(b)(3)(B) defines a QSub as a domestic corporation which is not an
ineligible corporation, if 100 percent of the stock of the corporation is owned by the S
corporation, and the S corporation elects to treat the corporation as a qualified
subchapter S subsidiary.
Section 1.1361-3(a) of the Income Tax Regulations prescribes the time and manner for
making an election to be classified a qualified subchapter S subsidiary.
Section 1.1361-3(a)(4) provides that an election to treat an eligible subsidiary as a
qualified subchapter S subsidiary may be effective up to two months and 15 days prior
to the date the election is filed or not more than 12 months after the election is filed.

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The proper form for making the election is Form 8869, Qualified Subchapter S
Subsidiary.
Section 1362(d)(2)(A) provides that an election under § 1362(a) will be terminated
whenever (at any time on or after the 1st day of the 1st 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 the termination shall be effective on and after the
date of cessation.
Section 1362(f) provides that if (1) an election under §§ 1362(a) or 1361(b)(3)(B)(ii) 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) or § 1361(b)(3)(C), (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 is a small business corporation
or a QSub, as the case may be, or (B) to acquire the shareholder consents, and (4) the
corporation 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 or a QSub, as the
case may be) 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 or a QSub, as the case may be, during
the period specified by the Secretary.
CONCLUSION
Based on the information submitted and the representations made, we conclude that
Company’s S corporation election may have been ineffective or subsequently
terminated because Companymay have had more than one class of stock. However,
we conclude that,if Company’s S election was ineffective or subsequently terminated,
such ineffectiveness or termination was inadvertent within the meaning of § 1362(f) of
the Code. Further, we conclude that the corrective actions taken by Companyand its
shareholders and by Sub 1eliminated any potential second class of stock of the
Companyunder § 1361 and eliminated any potential failure of Sub 1to meet the
requirement of § 1361(b)(3)(B)(i), and any potential failures were inadvertent under
§ 1362(f). Consequently, we rule that Companywill be treated as continuing to be an S
corporation from Date 6, and thereafter, provided that Company’s S election otherwise
is not terminated under § 1362(d). Pursuant to the provisions of § 1362(f), Sub 1will be
treated as a QSubfrom Date 6and thereafter, provided that its election is not otherwise
terminated.

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Except as specifically ruled upon above, no opinion is expressed as to the federal
income tax consequences of the facts described above under any other provision of the
code. In particular, no opinion is expressed or implied as to whether Companyor Sub 1
otherwise qualifies as a subchapter S corporation, or QSub, respectively, under § 1361.
Furthermore, no opinion is expressed or implied as to the shareholders’ basis in
Companyor Sub 2, the accumulated adjustments account or other tax attributes of
Companyor Sub 2as a result of the erroneous income tax reporting of Sub 2as a
QSub of Companyduring the four taxable years following Date 6.
The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and are accompanied by a perjury statement executed by an
appropriate party. While this office has not verified any of the material submitted in
support of this 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 the Power of Attorney on file with this office, a copy of this letter
ruling will be sent to the taxpayer’s representatives.
Sincerely,
Bradford R. Poston
Senior Counsel, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)
Enclosure (1)
Copy of Letter for § 6110 purposes