PLR 200030018: Family trust may hold S corporation stock

Plain-English summary

An S corporation shareholder established an irrevocable trust that could receive the corporation's nonvoting stock. The IRS ruled that the shareholder would be treated as the trust's owner under section 674(a), making the trust an eligible S corporation shareholder during that person's life. It also ruled that the trust property would not enter the shareholder's gross estate under sections 2036, 2037, 2038, or 2041 on the submitted facts, despite a limited power to replace trustees. If the named beneficiary survived the shareholder, the trust could qualify as an electing small business trust after the shareholder's death if the trustees made the required election. The rulings depend on the trust terms and proposed transactions described in the letter.

Ruling snapshot

• Question: Could the trust hold S corporation stock, avoid estate inclusion for the grantor, and later qualify as an electing small business trust?
• Outcome: Approved on the stated trust terms, with the later trust status requiring an election.
• Key authorities: IRC §§ 674(a), 1361(c)(2)(A)(i), 1361(e), and 2036 through 2041; Rev. Rul. 95-58.

Full text (IRS public release)

Internal Revenue Service               Department of the Treasury

Index Number:    671.00-00, 1361.03- Washington, DC 20224
01, 1361.03-03,

Number: 200030018                      Person to Contact:
Release Date: 7/28/2000
Telephone Number:

Refer Reply To:
CC:DOM:P&SI:2 - PLR-116677-99
Date:
April 28, 2000
X          =

A          =

B          =

C          =

D          =

Trust      =

Foundation      =

State      =

D1         =

D2         =

Dear                :
This letter responds to a letter dated September 30, 1999,
and subsequent correspondence, submitted by you on behalf of X,
A, and Trust, requesting certain rulings concerning the federal
income and estate tax consequences of the creation of Trust.

The information submitted states that X is a corporation
which has elected to be treated as a subchapter S corporation
effective for its taxable year beginning D1. X has two classes
of stock outstanding, Class A nonvoting stock and common voting
stock. These two classes of stock are identical in all respects,
except voting rights.

Trust is a trust established by A under the laws of State on
D2.    The current trustees of Trust are C and D.

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Article 2, paragraph (a), of Trust provides that, during the
life of B, the trustees may pay at any time and from time to time
such parts or all of the net income and principal to and among B
and B’s issue of all generations living from time to time,
equally or unequally and to the exclusion of any one or more of
them, as the trustees determine taking into consideration the
management role, if any, of any such person in X, or any
successor or related entity. Any net income not so paid shall be
accumulated and added to principal.

Article 2, paragraph (b), of Trust provides that, upon the
death of B, the trustees shall administer or distribute the trust
property remaining after providing for compliance with Article 2,
paragraph (a), to or for such persons, other than B, B’s estate,
B’s creditors or the creditors of B’s estate, in such manner,
interests and proportions, either in fee or upon any new trusts,
conditions, or limitations, as B may appoint by B’s last will
making specific reference to this special power of appointment.
The trustees shall divide any trust property as to which such
power of appointment is not effectively exercised into shares for
the then living issue of B, per stirpes, or if there is no such
issue, into shares for A’s then living issue, per stirpes, and
shall administer each share so set apart according to Article 2,
paragraph (c). If no issue of A survives B, upon B’s death the
trustees shall administer the trust property according to Article
2, paragraph (i).

Article 2, paragraph (i), of Trust provides that whenever
the trustees are directed to administer trust property according
to Article 2, paragraph (i), they shall distribute such property
to Foundation, or if it is not then in existence, to such one or
more charitable or educational organizations then described in
§ 170(c), and in such proportions if more than one, as the
trustees determine.

Article 3, paragraph (a), of Trust provides that the
trustees may at any time add any one or more organizations
described in §§ 501(c)(3) and 170(c)(2), not to exceed a total of
ten, to the class of beneficiaries eligible to receive
distributions under Article 2. Any such addition of
beneficiaries shall be by a written instrument signed by the
trustees and filed with the original trust instrument. The
trustees may irrevocably release this power at any time by
written instrument signed by them and filed with the original
trust instrument. The determination by the trustees to exercise
or release the power to designate additional beneficiaries of
Trust under Article 2 shall be final and binding on all persons.

Article 3, paragraph (b), of Trust provides that,
notwithstanding the provisions of Article 2, if A is treated as

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the owner of any portion of Trust under Article 2 pursuant to
Subchapter J, Subpart E, of the Code or similar provisions of any
state law, the trustees shall pay directly to the Internal
Revenue Service or any similar state agency the amount or amounts
necessary to satisfy A’s personal income tax liability
attributable to the trust or assets of the trust, calculated as
provided in the following sentence. The amount or amounts so
paid to any such agency during any year shall equal the amount by
which A’s personal income tax liability payable to such agency
exceeds A’s personal income tax liability computed as though A
were not treated as the owner of the Trust. Payments under
Article 3, paragraph (b) shall be paid from income and, to the
extent income is insufficient, from principal.

Article 5, paragraph (c), of Trust provides, in part, that
A, during A’s life and competency, and thereafter a majority of
the legally competent members of the oldest generation of A’s
issue of which there are legally competent members, shall have
the power to remove any trustee and appoint a successor;
provided, however, that A’s issue shall not have the power to
remove an original trustee, and further provided that the
successor trustee shall not be a person who is related or
subordinate to A or to any person having the power to remove
within the meaning of § 672(c).

Article 13 of Trust provides that the trustees may amend
Trust at any time to cause any trust created under Trust to
qualify as a permissible shareholder in an S corporation under
the Internal Revenue Code of 1986 or any subsequent federal tax
laws. Otherwise Trust is irrevocable and cannot be amended.

A represents that as soon as reasonably practicable after
receipt of the rulings requested, A will contribute either a
portion of A’s nonvoting stock in X or cash to Trust. If A
transfers cash to Trust, the trustees will then use the cash to
purchase outstanding shares of X’s nonvoting stock at a price
determined by an independent appraisal.

RULING REQUESTS 1 AND 2
X, A, and Trust request rulings that A will be treated as
the owner of Trust under § 674(a) and that Trust is a trust
described in § 1361(c)(2)(A)(i) and therefore is an eligible
shareholder in X, an S corporation.

Section 1361(b)(1) defines "small business corporation" as 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
subsection (c)(2), or an organization described in subsection

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(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 1361(c)(2)(A)(i) provides that, for purposes of
§ 1361(b)(1)(B), a trust all of which is treated (under subpart E
of part I of subchapter J of chapter 1) as owned by an individual
who is a citizen or resident of the United States may be a
shareholder.

Section 671 provides that where it is specified in subpart E
that the grantor or another person shall be treated as the owner
of any portion of a trust, there shall then be included in
computing the taxable income and credits of the grantor or the
other person those items of income, deductions, and credits
against tax of the trust which are attributable to that portion
of the trust to the extent that such items would be taken into
account under chapter 1 in computing taxable income or credits
against the tax of an individual.

Section 674(a) provides that the grantor shall be treated as
the owner of any portion of a trust in respect of which the
beneficial enjoyment of the corpus or the income therefrom is
subject to a power of disposition, exercisable by the grantor or
a nonadverse party, or both, without the approval or consent of
any adverse party.

Section 674(c) provides that § 674(a) shall not apply to a
power solely exercisable (without the approval or consent of any
other person) by a trustee or trustees, none of whom is the
grantor, and no more than half of whom are related or subordinate
parties who are subservient to the wishes of the grantor -- (1)
to distribute, apportion, or accumulate income to or for a
beneficiary or beneficiaries, or to, for, or within a class of
beneficiaries; or (2) to pay out corpus to or for a beneficiary
or beneficiaries or to or for a class of beneficiaries (whether
or not income beneficiaries). A power does not fall within the
powers described in § 674(c) if any person has a power to add to
the beneficiary or beneficiaries or to a class of beneficiaries
designated to receive the income or corpus, except where such
action is to provide for after-born or after-adopted children.

We conclude that A will be treated as the owner of Trust
under § 674(a). Accordingly, during A’s life, Trust will be a
permitted shareholder of an S corporation under
§ 1361(c)(2)(A)(i).

RULING REQUEST 3

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X, A, and Trust request a ruling that the value of the
property in Trust will not be includable in A’s gross estate for
federal estate tax purposes.

Section 2033 provides for the inclusion in the gross estate
of any property in which the decedent had an interest at the time
of his death.

Section 2035(a) provides that if a decedent made a transfer
(by trust or otherwise) of an interest in any property, or
relinquished a power with respect to any property, during the
three-year period ending on the date of the decedent’s death, and
the value of such property (or interest therein) would have been
included in the decedent’s gross estate under §§ 2036, 2037,
2038, or 2042 if such transferred interest or relinquished power
had been retained by the decedent on the date of his death, the
value of the gross estate shall include the value of any property
(or interest therein) which would have been so included.

Sections 2036, 2037, and 2038 provide that the value of the
gross estate shall include the value of all property to the
extent of any interest therein of which the decedent has at any
time made a transfer, under which the decedent retained an
interest in or a power over the transferred property.

In the present case, A has not retained any interest or
reversion in Trust nor does A have the power to alter, amend, or
revoke Trust. Neither A nor A’s spouse may serve as trustee of
Trust. A has retained the right to remove and replace the
trustees. However, any successor trustee selected by A cannot be
related or subordinate to A within the meaning of § 672(c).
Accordingly, A will not be treated as retaining the discretionary
powers of the trustee solely as a result of the retained power to
remove the trustee of Trust and appoint a successor trustee. See
Rev. Rul. 95-58, 1995-2 C.B. 191. In addition, A will not hold a
general power of appointment over the property in Trust.

Accordingly, we conclude that, based on the facts presented,
under the terms of Trust, A has not retained any power or
interest that would cause Trust to be includable in A’s gross
estate under §§ 2036, 2037, 2038, or 2041.

RULING REQUEST 4

X, A, and Trust request a ruling that, if B survives A, upon
A’s death, Trust will qualify during the life of B as an electing
small business trust within the meaning of § 1361(e) if the
trustees make the required election described therein.

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Section 1361(c)(2)(A)(v) provides that an "electing small
business trust" may be a shareholder in an S corporation.

Section 1361(e)(1)(A) provides that the term "electing small
business trust" means any trust if (i) such trust does not have
as a beneficiary any person other than (I) an individual, (II) an
estate, or (III) an organization described in paragraph (2), (3),
(4), or (5) of § 170(c), (ii) no interest in such trust was
acquired by purchase, and (iii) an election under § 1361(e)
applies to such trust.

Section 1361(e)(1)(B) provides that the term "electing small
business trust" shall not include (i) any qualified subchapter S
trust (as defined in § 1361(d)(3)) if an election under
§ 1361(d)(2) applies to any corporation the stock of which is
held by such trust, (ii) any trust exempt from tax under subtitle
A, and (iii) any charitable remainder annuity trust or charitable
remainder unitrust (as defined in § 664(d)).

Section 1361(e)(3) provides that an election under § 1361(e)
shall be made by the trustee. Any such election shall apply to
the taxable year of the trust for which made and all subsequent
taxable years of such trust unless revoked with the consent of
the Secretary.

We conclude that, if B survives A, upon A’s death, Trust
will qualify during the life of B as an electing small business
trust within the meaning of § 1361(e) if the trustees make the
required election described therein.

Except as specifically set forth above, no opinion is
expressed concerning the federal tax consequences of the facts
described above under any other provision of the Code.

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

Pursuant to a power of attorney on file with this office, a
copy of this letter is being forwarded to X.

Sincerely yours,
H. GRACE KIM
Assistant to the Chief Branch 2
Office of the Assistant Chief Counsel
(Passthroughs and Special Industries)
Enclosures: 2
Copy of this letter
Copy for § 6110 purposes