PLR 200651027: Expired post-death trust eligibility receives S termination relief

Plain-English summary

An S corporation's shareholder trust remained eligible for two years after a deemed owner's death, then became an ineligible shareholder. An eligible individual later purchased the stock. The IRS found the resulting S termination inadvertent under section 1362(f). It allowed continued S treatment from the death date and treated the trust as an eligible owner-held trust through the stock purchase, with the surviving deemed owner treated as owning its S stock. Relief requires an otherwise valid S election and consistent shareholder reporting of income, basis adjustments, and distributions. Failure to follow that reporting treatment makes the ruling void.

Ruling snapshot

• Question: May S status continue after a shareholder trust exceeds its two-year post-death eligibility period?
• Outcome: Approved: inadvertent termination relief with specified trust-owner treatment and consistent reporting.
• Key authorities: IRC §§ 1362(f), 1361(c)(2), 1366, 1367, 1368; Treas. Reg. § 1.1361-1(h).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200651027
Third Party Communication: None
Release Date: 12/22/2006
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
---------------------------------------
------------------------, ID No. -------------
--------------------------------
Telephone Number:
-------------------------------------
(202) 622-3050
-----------------------------
Refer Reply To:
CC:PSI:B01
PLR-157714-05
-
Date: August 30, 2006

X = ----------------------------------------
-------------------------

A = ----------------
---------------------------

B = ------------------
-------------------------

C = ---------------------
-------------------------

Trust = ----------------------------------------------------------

Date 1 = ----------------------

Date 2 = --------------------------

Date 3 = --------------------------

Date 4 = ----------------------

Dear ------------

This letter responds to a letter dated November 2, 2005, and subsequent correspondence submitted on behalf of X by its authorized representative, requesting relief under ' 1362(f) of the Internal Revenue Code.

The information submitted states that X elected to be treated as an S corporation effective Date 1. Trust, a trust that was treated (under subpart E of part 1 of subchapter

PLR-157714-05
2

J of chapter 1) as owned by A and B, was a shareholder of X. On Date 2, A died. Trust continued to qualify as a permissible S corporation shareholder under § 1361(c)(2)(A)(ii) for the 2-year period beginning on the day of the deemed owner's death and ending on Date 3.

On Date 3, Trust became an ineligible shareholder of X and X’s election to be an S corporation terminated. On Date 4, C, an eligible shareholder, purchased the shares.

X represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make any adjustments that the Commissioner may require, consistent with the treatment of X as an S corporation.

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 ' 1362(a) is in effect for such year.

Section 1361(b)(1)(B) provides that the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which does not have as a shareholder a person (other than an estate, a trust described in ' 1361(c)(2), or an organization described in § 1361(c)(6)) who is not an individual.

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 1361(c)(2)(A)(ii) and § 1.1361-1(h)(1)(ii) provide that for purposes of § 1361(b)(1)(B), a trust which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed owner and which continues in existence after such death, is a permitted shareholder, but only for the 2-year period beginning on the day of the deemed owner's death. Section 1.1361-1(h)(3)(i)(B) provides that if stock is held by a trust described in § 1.1361-1(h)(1)(ii), the estate of the deemed owner is generally treated as the shareholder as of the day of the deemed owner's death.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever the corporation ceases to be a small business corporation.

Section 1362(f) provides that if (1) an election under ' 1362(a) by any corporation (A) was not effective for the taxable year for which made (determined without regard to ' 1362(b)(2)) by reason of a failure to meet the requirements of ' 1361(b) or to obtain shareholder consents or (B) was terminated under ' 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in the ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after

PLR-157714-05
3

discovery of the circumstances resulting in the ineffectiveness or termination, steps were taken (A) so that the corporation is a small business corporation or (B) to acquire the shareholder consents; and (4) the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to ' 1362(f), agrees to make such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in the ineffectiveness or termination, the corporation will be treated as an S corporation during the period specified by the Secretary.

Based solely on the facts submitted and the representations made, we conclude X’s S corporation election terminated on Date 3 when Trust became an ineligible S corporation shareholder and that the termination was inadvertent within the meaning of § 1362(f).

We also hold that pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 2 and thereafter, provided X’s S corporation election was otherwise valid and provided that the election was not otherwise terminated under § 1361(d). From Date 2 through Date 4, Trust will be treated as a trust described in § 1361(c)(2)(A)(i), and B will be treated as the owner of the portion of Trust that consists of X stock. The shareholders of X must include their pro-rata share of the separately stated and nonseparately computed items of X as provided in § 1366, make any adjustments to basis as provided in § 1367, and take into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat themselves as described above, this ruling is null and void.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code.

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

PLR-157714-05
4

Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s authorized representative.

Sincerely,

Audrey W. Ellis
Senior Counsel, Branch 1
Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes