PLR 200441015: Merger of similar S corporation shareholder trusts approved

Plain-English summary

Two qualified Subchapter S trusts with the same beneficiary and substantially identical terms held shares of the same S corporation. The trustee proposed merging one trust into the other to simplify administration. The IRS ruled that the beneficiary's rights would not materially change, so the merger would not create gain, loss, or another taxable event for that beneficiary under §§ 61 and 1001. It also ruled that the trusts' merger provision did not itself make them ineligible as QSSTs and that the share transfer would not end the surviving trust's QSST election, provided both trusts qualified when the transfer occurred. The IRS did not independently rule that the corporation or trusts otherwise qualified.

Ruling snapshot

• Question: Would merging the trusts create taxable gain or invalidate the surviving trust's QSST election?
• Outcome: Approved on the stated facts, with the QSST ruling conditional on both trusts qualifying at transfer.
• Key authorities: IRC §§ 61, 1001, 1361(d)(3); Treas. Reg. § 1.1361-1(j)(7).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200441015
Release Date: 10/8/04
Index Number: 1361.03-02

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Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B1 – PLR-118346-03
Date:
March 02, 2004

Legend

H = ---------------------

W = --------------------

X = -----------------------------------------
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Y = --------------------------
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GRAT A = --------------------------------------------
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GRAT B = ---------------------------------------
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Non Exempt QSST A = ---------------------------------------------------
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Non Exempt QSST B = ----------------------------------------------------
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D1 = --------------------------

D2 = --------------------------

D3 = --------------------------

D4 = --------------------------
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N1 = ----------
N2 = --------

State = ----------------

Dear ----- ------------------:

This responds to your letter dated, March 17, 2003, on behalf of the taxpayer, Non Exempt QSST A, requesting a rulings under §§ 61, 1001, and 1361(d)(3) of the Internal Revenue Code.

FACTS

X is a corporation organized under the laws of State. It filed an election to be treated as an S corporation under § 1362(a), effective D1.

H and W, as grantors, formed GRAT A and GRAT B under the laws of State, on D2, for the benefit of Y. On D2, GRAT A and GRAT B acquired N1 shares of X nonvoting common stock and N2 shares of X voting common stock.

The instruments creating the GRATS provide, in part, that:

Article 2.1

From the date of this agreement until the fifth anniversary of the date of this Agreement or the Grantor=s earlier death (Athe Trust term@), the Trustee shall pay to the Grantor (the AAnnuitant@) an AAnnuity Amount@ ***.
Article 2.2

The Trust Term expires on the fifth anniversary of the date of this Agreement and Grantor=s daughter Y, or any of her descendants is living, the Trustee shall divide the trust assets as provided in Article 2.3 * * *.

Article 2.3

If the Trust Term expires on the Grantor’s death and the Grantor has revoked his wife’s interest, or the Grantor’s wife did not survive the Grantor, then such portion of the trust assets as are includible in the Grantor’s estate for federal estate tax purposes shall be distributed to the personal representative of Grantor’s estate. The remaining assets, if any, shall be distributed as provided in Article 2.2.
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Article 3.2.1

If Y is living at the time the trust estate is received by the Trustee, the Trustee shall hold the property of the trust estate as a separate Non Exempt Trust for the benefit of Y under the provisions of this Article.

Article 3.3

The Trustee may distribute to, or for the benefit of, the beneficiary of each Non Exempt Trust so much of the net income and principal of the trust, up to the whole thereof, as the Trustee determines is required to provide for the beneficiary’s health, support, maintenance and education. In addition, the Trustee may pay from each beneficiary’s trust any tuition or health care expenses for the benefit of the beneficiary’s descendants, provided that such payments are made directly to the educational institution or health care provider, respectively, and that such payments are not subject to the generation-skipping tax.

Article 3.4

Any income of a trust no distributed in a calendar year shall be accumulated and added to principal at or prior to the end of such year.

Article 3.6

The Non Exempt Trust for Y shall terminate upon his death. * * *

Article 5.6

The Trustee of two or more trusts created by this or any other instrument may merge such trusts if the beneficiary or beneficiaries are the same and the terms of the trusts are substantially the same.

Article 5.10.1

The beneficiary (or the beneficiary=s legal representative) may elect to have § 1361(d)(2) of the Code apply to one or more of such corporations.
If such an election is made, all provisions of the trust shall be interpreted, construed and administered in a manner consistent with the Grantor=s intention that the trust be treated for all purposes as a qualified Subchapter S trust.

Article 5.10.2
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Notwithstanding any provision of this Agreement directing otherwise, if rules applicable to a qualified Subchapter S trust at the time when Subchapter S stock is distributable to the trust in monthly or quarterly installments to, or for the benefit of, the beneficiary, and no distributions of income or principal from the trust go to any other person except the beneficiary during the beneficiary=s lifetime.

On D3, GRAT A’s term expired, resulting in Non Exempt QSST A being formed on D4. GRAT A transferred N2 shares of X voting common stock and N1 shares of X nonvoting common stock to Non Exempt QSST A. On D3, GRAT B’s term also expired, resulting in Non Exempt QSST B being formed on D4. GRAT B transferred N2 shares of X voting common stock, and N1 shares of X nonvoting common stock to Non Exempt QSST B. Non Exempt QSST A and Non Exempt QSST B each filed a qualified subchapter S trust (“QSST”) election under § 1361(d)(2), effective D4.

Non Exempt QSST B proposes to merge with and into Non Exempt QSST A pursuant to Article 5.6 of the GRAT agreements. In addition to the facts discussed above, the taxpayer represents the following:

$ No additions have been made to Non Exempt QSST A or to Non Exempt QSST B since initial funding.

$ The terms and provisions of Non Exempt QSST A and Non Exempt QSST B are substantially identical;

$ Y is the beneficiary of both Non Exempt QSST A and Non Exempt QSST B;

$ Non Exempt QSST A and Non Exempt QSST B have continuously qualified as QSSTs since the D3 effective date of their QSST elections;

$ X has consistently treated Y as the owner of the X stock held by Non Exempt QSST A and Non Exempt QSST B, and all of Y’s tax returns have been filed consistent with that status;

$ The merger will not change the quality or value of Y’s interest in either Non Exempt QSST A’s or Non Exempt QSST B’s assets, and that it will not confer upon Y any additional powers or beneficial interests;

$ The merger is being proposed to simplify the management and administration of the trusts.

Following the merger, the terms of Non Exempt QSST A will continue to provide that (1) during the life of the current income beneficiary there shall be only one income
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beneficiary of trust; (2) any corpus distributed during the life of the current income beneficiary may be distributed only to the income beneficiary; (3) the income interest of the current income beneficiary in the trust shall terminate on the earlier of the beneficiary’s death or termination of the trust; and (4) upon the termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to that beneficiary, and (5) all of the income will be distributed (or required to be distributed) currently to one individual who is a citizen or resident of the United States.

LAW AND ANALYSIS

Sections 61 and 1001 Ruling

Section 61 of the Code provides that gross income means all income from whatever source derived.

Section 61(a)(3) provides that gross income includes gains derived from dealings in property.

Section 1001(a) provides that the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in § 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.

Section 1001(b) provides that the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property received. Section 1001(c) provides that, except as otherwise provided in subtitle A, the entire amount of the gain or loss, determined under § 1001, on the sale or exchange of property shall be recognized. Section 1.1001-1(a) of the Income Tax Regulations provides that the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or as loss sustained.

In Cottage Savings Assoc. v. Commissioner, 499 U.S. 554 (1991), the Supreme Court addressed whether a sale or exchange has taken place that results in a realization of gain or loss under § 1001 of the Code. The Court stated that an exchange of property gives rise to a realization event under § 1001(a) if the properties exchanged are materially different. Consequently, the Court held that an exchange of mortgages constituted a realization event under § 1001(a) because the exchanged interests - loans that were made to different obligors and secured by different homes - were legally distinct entitlements.

Section 1361(d)(3) Ruling

Section 1361(a)(1) defines an S corporation as a small business corporation for which an election under § 1362(a) is in effect. Section 1361(b)(1) defines Asmall
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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 § 1361(c)(2), or an organization described in (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 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 subchapter S corporation shareholder.

Section 1361(d)(1) states that a QSST, with respect to which a beneficiary makes an election under § 1361(d)(2), will be treated as a trust described in § 1361(c)(2)(A)(i), and the QSST’s beneficiary will be treated as the owner (for purposes of § 678(a)), of that portion of the QSST’s S corporation stock to which the election under § 1361(d)(2) applies.

Under § 1361(d)(2)(A), the beneficiary of a QSST may elect to have § 1361(d) apply. Under § 1361(d)(2)(D), this election will be effective up to 15 days and two months before the date of the election.

Section 1361(d)(3)(A) provides that a QSST is a trust, the terms of which require that (i) during the life of the current income beneficiary there shall be only 1 income beneficiary of the trust, (ii) any corpus distributed during the life of the current income beneficiary may be distributed only to such beneficiary, (iii) the income interest of the current income beneficiary in the trust shall terminate on the earlier of such beneficiary’s death or the termination of the trust, and (iv) upon the termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to such beneficiary. In addition, § 1361(d)(3)(B) requires that the trust distribute all of its income (within the meaning of § 643(b)) currently to one individual who is a citizen or resident of the United States.

Section 1.1361-1(j)(7) provides that the beneficiary of the QSST who is treated as the owner of that portion of the trust that consists of S corporation stock is treated as the shareholder for the purpose of § 1361(b)(1)(defining the term Asmall business corporation@).

CONCLUSION

Sections 61 and 1001 Ruling

In the present case, the terms and conditions of each of the merged trusts are substantially identical to the terms and conditions of each of the surviving trusts. Because the property interests and legal entitlements of the beneficiaries will remain unchanged by the proposed mergers, it is consistent with Cottage Savings to find that the beneficiaries’ interests after the proposed mergers will not differ materially from the
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beneficiaries’ interests before the proposed merger. Thus, the proposed mergers will not result in the realization of any gain or loss or other taxable event under §§ 61 or 1001 of the Code to the current trust beneficiary.

Section 1361(d)(3) Ruling

Article 5.6 of the instrument creating Non Exempt QSST A and Non Exempt QSST B allows for a merger of similar trusts only when the trusts have the same income beneficiary. Under §1.1361-1(j)(7), the X shares which make up the corpus of Non Exempt QSST A and Non Exempt QSST B are treated as directly owned by Y. Any transfer of the X shares, pursuant to a merger under Article 5.6, would effectively be a transfer of the shares from Y to Y. Therefore, inclusion of Article 5.6 permitting the merger of similar trusts did not make either trust ineligible to be a QSST. Provided that both Non Exempt QSST A and Non Exempt QSST B qualified as QSSTs on the date that Non Exempt QSST B transferred its X shares to Non Exempt QSST A, the transfer did not terminate Non Exempt QSST A’s QSST election.

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. Specifically, no opinion is expressed on whether X is a subchapter S corporation for federal tax purposes, or whether any of the trusts discussed qualify as QSSTs.

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

Pursuant to the power of attorney on file with this office, a copy of this letter is being sent to the taxpayer.

Sincerely,
/s/ Dan Carmody
Dan Carmody
Senior Counsel, Branch 1
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)
Enclosures (2)
Copy of this letter
Copy for § 6110 purposes
cc: