Letter ruling - Activities of S corporation not attributable to exempt parent 

July 22: The IRS ruled that ownership interest of an exempt organization (a faculty group practice) in a newly formed subchapter S corporation would have no effect on the organization’s tax-exempt status under section 501(c)(3). PLR 201328035 (release date July 12, 2013, and dated April 16, 2013)

Read the letter ruling: PLR 201328035 [PDF 378 KB]


A faculty group practice—recognized as exempt from federal income tax as an organization described in section 501(c)(3) and classified as a public charity under section 509(a)(3)—supports part of a state-chartered university.

As part of a restructuring plan, the organization intends to contribute shares in another entity to a newly formed organization that will make a qualified subchapter S subsidiary election, resulting in the organization owning—through a disregarded subsidiary—ownership interests in an S corporation.

IRS ruling

The IRS ruled that the organization’s ownership interest in the newly formed subchapter S corporation would have no effect on the organization’s tax-exempt status as an organization described in section 501(c)(3)

Section 1361(c)(6) permits organizations described in sections 401(a) or 501(c)(3) that are exempt from taxation under section 501(a) to be shareholders in an S corporation. However, section
512(e) provide that all items of income or loss of an S corporation will flow through to such tax-exempt shareholders as unrelated taxable income regardless of the source or nature of such income. In addition, section 512(e) provides that any gain or loss on the sale or other disposition of stock of an S corporation will be treated as unrelated business taxable income.

The IRS clarified that these special rules do not cause the for-profit activities of the S corporation to be attributed to the tax-exempt shareholder and stated that the activities of a for-profit subsidiary will not be attributed to its tax-exempt parent unless:

  • The subsidiary lacks a business purpose; or
  • The subsidiary is an arm or agent of the parent, using a Moline Properties-type analysis.*

*Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943).

Finding that the organization did not fail either prong of the test, the IRS ruled that the organization’s tax-exempt status would not be jeopardized by its ownership in the S corporation, together with the flow-through allocation of the tax items subject to the unrelated business income tax.

The letter ruling did not address any issues related to section 509(a)(3).

For more information, contact:

Rick Speizman, Partner-in-Charge of KPMG's Washington National Tax Exempt Organizations Tax group

+1 (202) 533-3084

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