Ceases to be Small Business Corporation

Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 202627008
Release Date: 7/2/2026
Index Number: 1361.01-04, 1362.00-00,
1362.02-00, 1362.02-02
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Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PT&E:B01
PLR-117066-25
Date:
April 01, 2026
LEGEND
X = ---
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State = ---
Date 1 = ---
Date 2 = ---
Date 3 = ---
Month = ---
Dear ---:
This responds to a letter dated September 22, 2025, and subsequent correspondence, submitted on behalf of X by X’s authorized representatives, requesting relief under § 1362(f) of the Internal Revenue Code (the Code).

# FACTS

X was organized on Date 1 under the laws of State. X elected to be treated as an S corporation effective Date 1. On Date 2, X adopted an operating agreement that contained terms causing X to have more than one class of stock under § 1361(b)(1)(D).
Specifically, the agreement contained provisions regarding the maintenance of capital accounts in accordance with § 704(b) and based each member's liquidating distribution PLR-117066-25 2 rights on their capital account balances. Thus, X’s S corporation status terminated on Date 2. Additionally, X inadvertently made disproportionate distributions to shareholders prior to Date 3. Subsequently, X amended its operating agreement, effective Date 3, to reflect its intent to be treated as an S corporation, remove any language related to capital accounts, and provide that all shares of its stock confer identical distribution and liquidation rights. During Month, X amended certain employment tax returns to reflect the intended treatment of the disproportionate distributions as compensation.

# 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(l)(1) 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(l)(2)(i) provides, in part, 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, governing provisions).
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) will be terminated whenever (at any time on or after the first day of the first taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation. Section 1362(d)(2)(B) further provides that the termination shall be 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 terminated under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (2) the Secretary determines that the circumstances resulting in such termination were inadvertent; (3) no later than a reasonable period of time after discovery of the circumstances resulting in such termination, steps were taken so that the corporation for PLR-117066-25 3 which the termination occurred is a small business corporation or a qualified subchapter S subsidiary, as the case may be; and (4) the corporation for which the election was made or 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 or a qualified subchapter S subsidiary, as the case may be) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in such termination, such corporation shall be treated as an S corporation or a qualified subchapter S subsidiary, as the case may be, 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 terminated on Date 2 due to provisions in X’s former operating agreement that created a second class of stock. However, we conclude that the termination of X's S corporation election was inadvertent within the meaning of § 1362(f). Accordingly, under § 1362(f), X will continue to be treated as an S corporation from Date 2 and thereafter, provided that X's S corporation election was valid and has not otherwise terminated under § 1362(d).
Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the facts of this case under any other provisions of the
Code. Specifically, we express or imply no opinion as to whether X is otherwise eligible to be an S corporation.
This ruling is directed only to the taxpayer requesting it. According to § 6110(k)(3) of the
Code, this ruling may not be used or cited as precedent.
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 ruling request, it is subject to verification on examination.
Under a power of attorney on file with this office, we are sending a copy of this letter to
X's authorized representatives.
PLR-117066-25
Enclosure:
Copy for § 6110 purposes
4
Sincerely,
____
Joy C. Spies
Senior Technician Reviewer, Branch 1
Office of Associate Chief Counsel
(Passthroughs, Trusts, and Estates) cc: ---
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