A taxpayer that ended up buying back his S corporation stock from a corporation he had sold it to found the IRS was not willing to waive the requirement under IRC §1362(g) that the corporation would not be allowed to re-elect S status for five years (PLR 201636033).
In this case the individual, holder of 100% of the S corporation’s stock, sold the stock to another corporation. The transfer of the shares to the corporation resulted in a termination of the corporation’s S status at that time. Less than five years later the shareholder bought the stock back from the buyer—but now had a C corporation.
IRC §1362(g) provides:
(g) Election after termination
If a small business corporation has made an election under subsection (a) and if such election has been terminated under subsection (d), such corporation (and any successor corporation) shall not be eligible to make an election under subsection (a) for any taxable year before its 5th taxable year which begins after the 1st taxable year for which such termination is effective, unless the Secretary consents to such election.
In Reg. §1.1362-5(a) the IRS outlines the general requirements a corporation must meet to obtain the IRS’s consent via a private letter ruling:
(a) In general.
Absent the Commissioner's consent, an S corporation whose election has terminated (or a successor corporation) may not make a new election under section 1362(a) for five taxable years as described in section 1362(g). However, the Commissioner may permit the corporation to make a new election before the 5-year period expires. The corporation has the burden of establishing that under the relevant facts and circumstances, the Commissioner should consent to a new election. The fact that more than 50 percent of the stock in the corporation is owned by persons who did not own any stock in the corporation on the date of the termination tends to establish that consent should be granted. In the absence of this fact, consent ordinarily is denied unless the corporation shows that the event causing termination was not reasonably within the control of the corporation or shareholders having a substantial interest in the corporation and was not part of a plan on the part of the corporation or of such shareholders to terminate the election.
The taxpayer in this case asked the IRS, considering the situation, to allow for an early election back into S status. The IRS declined to do so.
As the ruling explained:
In the present case, based on all of the facts submitted and representations made, all of the stock in X is currently held by A, who owned all of the stock in X on the date of the termination. Thus, not more than 50 percent of the stock in X is owned by persons who did not own stock in X on the date of the termination. Further, the event causing the termination, the acquisition by a C corporation, Y, of the stock of X, was reasonably within the control of X and its shareholders.
Accordingly, X is denied permission to reelect to be an S corporation prior to the expiration of the 5-year period prescribed by § 1362(g) of the Code.
We certainly don’t know all of the facts in this case, but presumably the taxpayer did not intend to buy the stock back after he sold the stock to the corporation in question, but some event or events lead to that eventuality. But it’s important to note that the regulation only addresses whether the event causing termination was under the control of the shareholder. Clearly the taxpayer sale of stock to a C corporation was an event which could easily be foreseen to terminate the S election.
Similarly, the regulation simply looks at the shareholders at the termination and those shareholders at the time relief is requested. The fact that this individual was not a shareholder in the interim is also not a factor provided for in the regulations.
While the regulation does not absolutely state that relief will not be granted if neither of these conditions are met, the IRS did not decide to grant relief in this ruling as an “out of the ordinary” case.