CORPORATION'S S ELECTION INADVERTENTLY INEFFECTIVE.

Index Number: 1361.01-04, 1362.00-00

[1] In a letter, dated July 8, 1998, and a supplemental submission, dated December 1, 1999, you requested rulings under sections 1361 and 1362 of the Internal Revenue Code.

[2] The information submitted and the representations made are summarized as follows: Prior to the end of a, Company was an S corporation with a single class of common stock authorized. Effective b, Company became a C corporation.

[3] Company adopted the Plan, effective c. The Trust established pursuant to the Plan purchased approximately d percent of the outstanding common stock of Company. The remaining outstanding stock of Company is held by A, an individual.

[4] On e, the shareholders of Company approved an amendment to Company's Certificate of Incorporation, which provided for the division of the single class of common stock into two classes of common stock: (1) Class A Common Stock, and (2) Class B Common Stock.

[5] Article 4 of the Certificate of Incorporation was amended to provide as follows:

          The total number of shares of capital stock which this

[7] On j, Company filed an election to be an S corporation, effective k.

[8] Company was not aware that the e amendment to Article 4 of the Certificate of Incorporation created a second class of stock that would cause Company's S election to be ineffective. When company became aware that it had two classes of stock, to remedy the situation, on l, the Certificate of Incorporation was amended as follows:

          1. Article Fourth of Company's Certificate of Incorporation

[10] You have requested the following rulings:

1. Company's election to be treated as an S corporation, effective on j, was inadvertently ineffective within the meaning of section 1362(f), and that Company will be treated as an S corporation from j, and thereafter, provided Company's S election is not otherwise terminated under the provisions of section 1362(d).

2. Article 4 of the Certificate of Incorporation, as amended on k, does not create a second class of stock under section 1361(b)(1)(D) and the regulations thereunder.

[11] 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 section 1362(a) is in effect for the year.

[12] Section 1361(b)(1) provides that for purposes of subchapter S, the term "small business corporation" means a domestic corporation that is not an ineligible corporation and that does not --

(A) have more than 75 shareholders.

(B) have as a shareholder a person (other than an estate, a trust described in section 1361(c)(2), or an organization described in section 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.

[13] Section 1.1361-1(l)(1) of the Income Tax Regulations provides that a corporation that has more than one class of stock does not qualify as a small business corporation. Except as provided in section 1.1361-1(l)(4) (relating to instruments, obligations, or arrangements treated as a second class of stock), a corporation is 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. Differences in voting rights among shares of stock of a corporation are disregarded in determining whether a corporation has more than one class of stock. Thus, if all shares of stock of an S corporation have identical rights to distribution and liquidation proceeds, the corporation may have voting and nonvoting common stock, a class of stock that may vote only on certain issues, irrevocable proxy agreements, or groups of shares that differ with respect to rights to elect members of the board of directors.

[14] Section 1.1361-1(l)(2) provides 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, by laws, applicable state law, and binding agreements relating to distribution and liquidation proceeds (collectively, the governing provisions). A commercial contractual agreement, such as a lease, employment agreement, or loan agreement, is not a binding agreement relating to distribution and liquidation proceeds and thus is not a governing provision unless a principal purpose of the agreement is to circumvent the one class of stock requirement of section 1361(b)(1)(D) and section 1.1361-1(l). Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances.

[15] Section 1362(f) provides that if --

     (1) an election under section 1362(a) by any corporation --

(3) no later than a reasonable period of time after discovery of the circumstances resulting in the ineffectiveness or termination, steps were taken --

     (A) so that the corporation is a small business corporation, or

then notwithstanding the circumstances resulting in the ineffectiveness or termination, the corporation is to be treated as an S corporation during the period specified by the Secretary.

RULING NO. 1

[16] Based solely on the information submitted and the representation made, we conclude that Company's election to be treated as an S corporation was invalid because on k, Company had more than one class of stock. We also conclude that the invalid election was inadvertent, within the meaning of section 1362(f). Pursuant to section 1362(f), Company will be treated as an S corporation for the period beginning k, and thereafter, provided Company's S election was otherwise valid and was not terminated under the provisions of section 1362(d).

[17] Company and all its current and former shareholders must treat Company as having been an S corporation for the period beginning k, and thereafter. Accordingly, all current and former shareholders, in determining their respective income tax liabilities for the period beginning k, and thereafter, must include the pro rata share of the separately and nonseparately computed items of Company as provided in section 1366, make adjustments to stock basis as provided in section 1367, and take into account any distributions made by Company as provided by section 1368. If Company or any of its current or former shareholders fail to treat Company as having been an S corporation for the period beginning k, and thereafter, as described above, this ruling shall be null and void.

RULING NO. 2

[18] Based solely on the information submitted and the representation made, we conclude that the amendment to the Article 4 of the Certificate of Incorporation does not create a second class of stock under of section 1361(b)(1)(D).

[19] Except as specifically ruled in this letter, we express or imply no opinion concerning the federal tax consequences of this transaction under the cited provisions or any other provision of the Code. Specifically, we express or imply no opinion concerning whether Company is otherwise a valid S corporation for federal tax purposes.

[20] This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

[21] In accordance with the power of attorney on file with this office, a copy of this letter is being sent to your authorized representative.

                                   Sincerely yours,