PLR Probably Closing Condition for Target S Corporation’s 2-Class Stock Issue

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M&A Tax Stories

September 2, 2020

Introduction

A buyer of an S corporation wants to make sure that the target is in fact an S corporation. Finding out after closing risks potentially significant federal and state corporate income taxes.

The deal

In this deal the target during due diligence discovered that the corporation had two classes of stock. An S corporation can only have one class of stock.

One target class of stock was voting stock and the other nonvoting stock. That difference did not cause any S corporation qualification issues.

The problem was caused when the corporation later changed the capital structure by creating different distribution and liquidation rights for the two classes of stock. Different distribution and liquidation rights and violates the one class of stock requirement.

The private letter ruling

The target immediately changed the capital structure to one class of stock, each share with the same distribution and liquidation rights. Then, the target asked the IRS to issue a private letter ruling waiving the inadvertent creation of the two classes of stock in order to save the S election.

The IRS issued a private letter ruling concluding that the creation of two classes of stock was inadvertent and waiving the violation of the 2 class of stock requirement.

Private Letter Ruling 201935010 Release Date: 8/30/2019   https://www.irs.gov/pub/irs-wd/201935010.pdf

Comment 

The private letter ruling process can kill a deal. That is because it can take up to 6 months to get a ruling.

Best for the target to do due diligence on itself before putting the company up for sale. However, the target must keep in mind that there will be significant professional fees and an IRS user fee to fix a problem like this. I believe the IRS user fee is currently $30,000.

By John McCauley: I help people with M&A tax issues involving privately held companies.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

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