IRS Grants Relief for Early S Corporation Re-Election After Termination

IRS Permits Early S Corporation Re-Election Despite Five-Year Waiting Period

The IRS granted permission for X to re-elect S corporation status effective Date 3—prior to the expiration of the five-year waiting period under Internal Revenue Code § 1362(g)—after C acquired 100% of X’s interests from A and B on that date. The IRS issued a non-precedential private letter ruling (PLR-114883-25) approving the early re-election, concluding that the new ownership structure justified relief from the statutory restriction.

The Taxpayer's Request: Bypassing the Five-Year Waiting Period

X initially elected S corporation status for Date 1, but the election terminated effective Date 2 due to an involuntary disqualifying event—likely a violation of S corporation eligibility rules under Internal Revenue Code § 1361(b), such as exceeding the 100-shareholder limit or acquiring an ineligible shareholder. Under § 1362(g), involuntary terminations trigger a mandatory five-year waiting period before the corporation may re-elect S status, unless the IRS grants relief. The statute imposes this restriction to prevent taxpayers from frequently switching between S and C corporation tax treatments for tax planning purposes.

Following the termination, C acquired 100% of X’s interests from the original owners, A and B, on Date 3. At the time of termination, C had no ownership stake in X, meaning the disqualifying event occurred under prior ownership. Despite the five-year waiting period still being in effect, X sought permission from the IRS to re-elect S corporation status effective Date 3—the same day C completed the acquisition. The request hinged on whether the change in ownership justified an exception to the statutory restriction.

IRS Rationale: New Ownership Justifies Early Re-Election

The IRS granted X’s request for early re-election under Treasury Regulation § 1.1362-5(a), which allows the Commissioner to waive the five-year waiting period under § 1362(g) if the corporation demonstrates compelling facts and circumstances warranting relief. The regulation explicitly states that the IRS may permit an early re-election if the corporation meets its burden of proof under the regulation’s criteria.

In this case, the IRS focused on the change in ownership structure as the decisive factor. Under § 1.1362-5(a), one of the key indicia that consent should be granted is when more than 50% of the stock is owned by persons who did not hold stock at the time of the termination. Here, C acquired 100% of X’s interests from the original owners, A and B, and had no ownership stake at the time of the disqualifying event. The IRS concluded that this complete shift in ownership removed the rationale for enforcing the five-year waiting period, as the new ownership structure effectively severed any continuity with the prior disqualifying circumstances.

The IRS determined that X met its burden under the regulation by showing that the termination was not part of a plan to manipulate S corporation status and that the new ownership structure justified an exception to the statutory restriction. The agency emphasized that the absence of prior ownership ties among the new shareholders weighed strongly in favor of granting relief, as it demonstrated that the disqualifying event was not a product of the corporation’s or its original shareholders’ actions.

Implications: Relief for Taxpayers with New Ownership Structures

The IRS’s decision in this PLR signals potential relief for taxpayers facing involuntary S corporation terminations due to ownership changes, provided the new structure meets specific criteria. While the ruling is non-precedential, it underscores the IRS’s willingness to consider exceptions to the five-year waiting period under Section 1362(g) when a corporation undergoes a substantial change in ownership—defined as more than 50% of the stock being owned by persons who did not hold shares at the time of termination. This exception hinges on demonstrating that the disqualifying event was not part of a plan to manipulate S corporation status, a principle reinforced by Treas. Reg. § 1.1362-5(a), which grants the IRS discretion to waive the waiting period for inadvertent terminations.

Taxpayers in industries prone to ownership restructuring—such as mergers, acquisitions, or generational transfers—may now have a clearer path to early re-election if they can substantiate that the termination arose from an unforeseen change in control. For example, corporations that inadvertently exceed the 100-shareholder limit due to a merger or stock distribution from an employee stock ownership plan (ESOP) could qualify for relief if the new ownership structure is unrelated to the original shareholders. Similarly, entities that inherit ineligible shareholders (e.g., non-resident aliens) through estate planning may find this ruling persuasive in seeking waivers, provided they act swiftly to correct the issue.

However, the procedural hurdles remain significant. Taxpayers must file Form 2553 within 120 days of receiving the PLR to validate the election, and they must still satisfy all other S corporation eligibility requirements, including the one-class-of-stock rule and shareholder composition. The IRS’s emphasis on the absence of prior ownership ties among new shareholders suggests that transactions structured to exploit tax benefits—such as temporary ownership shifts to reset the five-year clock—are unlikely to succeed. For industries with complex ownership arrangements, such as private equity or venture capital-backed entities, this ruling serves as a reminder to conduct pre-transaction due diligence to avoid unintended terminations.