IRS written determination 201426010

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: 201426010
Release Date: 6/27/2014
Index Number: 1362.04-00, 1362.02-03
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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:B01
PLR-139004-13
Date:
February 27, 2014
LEGEND
X=--------------------------
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Y=------------------------------------------
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Z=--------------------------
D1=--------------------------
D2=--------------------
D3=-----------------
D4=---------------------
D5=--------------------------
Year1=--------------------------
Year2=--------------------------
Year3=--------------------------------
State=------------
$a=----------------
$b=---------------------

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Dear -------------:
This responds to a letter dated September 6, 2013, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting inadvertent
termination relief under § 1362(f) of the Internal Revenue Code.
FACTS
According to the information submitted and representations made, Y was incorporated
on D1, under the laws of State. Effective D2, Y elected to be taxed as an S corporation.
On D3, Z acquired most of the assets of Y and Y was renamed X.
For X’s taxable years ending Year1, Year2, and Year3, X’s passive investment income
exceeded 25% of its gross receipts. Furthermore, X had C corporation accumulated
earnings and profits (AE&P) for each of the years stated above. As a result, X’s S
election terminated on D4.
X represents that it will make a distribution of its AE&P of $a before D5.
X represents that its tax advisors inadvertently failed to inform X of the passive
investment rules. In addition, X represents that it has always intended to maintain its S
corporation status and that the termination of X’s S election was inadvertent and did not
involve retroactive tax planning or tax avoidance. X further represents that X and its
shareholder continued to consistently treat X as an S corporation and that X and its
shareholder agree to make any adjustments required as a condition of obtaining relief
under the inadvertent termination rule of § 1362(f) that 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 1
class of stock.
Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated

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whenever (at any time on or after the 1st day of the 1st taxable year for which the
corporation is anS corporation) such corporation ceases to be a small business
corporation.
Section 1362(d)(3)(A)(i) provides that an election under § 1362(a) shall be terminated
whenever the corporation (I) has accumulated earnings and profits at the close of each
of 3 consecutive taxable years, and (II) has gross receipts for each of such taxable
years more than 25 percent of which are passive investment income.
Section 1362(d)(3)(C)(i) provides that except as otherwise provided in § 1362(d)(3)(C),
the term “passive investment income” means gross receipts derived from royalties,
rents, dividends, interest, and annuities.
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 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 termination occurred is a small
business corporation; and (4) the corporation for which 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
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.
Section 1.1362-4(b) provides, in relevant part, that the determination of whether a
termination was inadvertent is made by the Commissioner. The corporation has the
burden of establishing that under the relevant facts and circumstances the
Commissioner should determine that the termination was inadvertent. The fact that the
terminating event was not reasonably within the control of the corporation and, in the
case of a termination, was not part of a plan to terminate the election, or the fact that the
terminating event or circumstance took place without the knowledge of the corporation,
notwithstanding its due diligence to safeguard itself against such an event or
circumstance, tends to establish that the termination of the election was inadvertent.
Section 1.1362-4(d) provides that the Commissioner may require any adjustments that
are appropriate. In general, the adjustments required should be consistent with the
treatment of the corporation as an S corporation during the period specified by the
Commissioner.
Section 1375 imposes a tax on the income of an S corporation that has accumulated

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earnings and profits at the close of a taxable year, and that has gross receipts more
than 25% of which are passive investment income (within the meaning of § 1362(d)(3)).
Section 1375(b)(1)(B) provides that the amount of the excess net passiveincomefor
any taxable year shall not exceed the amount of the corporation’s taxable income for
such taxable year as determined under § 63(a)--(i) without regard to the deductions
allowedby part VIII of subchapter B (other than the deduction allowed by § 248, relating
to organizational expenditures), and (ii) without regard to the deduction under § 172.
Section 1.1368-1(f)(3) provides that an S corporation may elect to distribute all orpart of
its accumulated earnings and profits through a deemed dividend. If an S corporation
makes the election provided in § 1.1368-1(f)(3), the S corporation will be considered to
have made the election under § 1368(e)(3) and § 1.1368-1(f)(2) to distribute earnings
and profits first.
Section 1.1368-1(f)(5)(iii) provides that a corporation makes an election for a taxable
year under § 1368-1(f) by attaching a statement to a timely filed (including extensions)
original or amended return required to be filed under § 6037 for that taxable year. In the
statement, the corporation must identify the election it is making under § 1368-1(f) and
must state that each shareholder consents to the election. In the case of elections for
taxable years beginning before January 1, 2003, an officer of the corporation must sign
under penalties of perjury the statement on behalf of the corporation. In the case of
elections for taxable years beginning after December 31, 2002, the statement described
in this paragraph (f)(5)(iii) shall be verified by signing the return. A statement of election
to make a deemed dividend under § 1368-1(f) must include the amount of the deemed
dividend that is distributed to each shareholder.
CONCLUSION
Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on D4, because for three consecutive years, X
had AE&P and more than 25 percent of X’s income was passive activity income under
§ 1362(d)(3)(A). We further conclude that the termination of X’s S election on D4 was
inadvertent within the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), X
will be treated as continuing to be an S corporation on and after D4, provided X’s S
corporation election was valid and is not otherwise terminated under § 1362(d). This
letter ruling is subject to the following conditions: (1) An adjustment under § 1362(f)(4),
a payment of $b and a copy of this letter must be sent to the following address: Internal
Revenue Service, Cincinnati Service Center, 201 West Rivercenter Blvd., Covington,
KY 41011, Stop 31, Terri Lackey, Manual Deposit. This payment must be sent no later
than 120 days from the date of this letter; and (2) X actually making a distribution of all
of its AE&P of $a through a distribution on D5. If these conditions are not met, then this
ruling is null and void. Furthermore, if these conditions are not met, X must send
notification that its S election has terminated to the service center with which X’s S

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election was filed.
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. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation.
This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3),
this ruling may not be used or cited as precedent.
Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to your authorized representative.
Sincerely,
David R. Haglund
David R. Haglund
Branch Chief, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)
Enclosures (2)
Copy of this letter
Copy of this letter for section 6110 purposes
cc: