PLR 200840003: Ineligible trust ownership does not end S corporation status

Plain-English summary

An ineligible trust acquired stock in an S corporation, which terminated the corporation's S election. After discovering the problem, the corporation transferred the trust's shares to its two individual income beneficiaries, both eligible S corporation shareholders. The IRS found the termination inadvertent and treated the corporation as continuously maintaining S status, provided its election was otherwise valid. The shareholders must report the corporation's items, basis adjustments, and distributions consistently with the ruling, with the two beneficiaries treated as shareholders during the trust-ownership period.

Ruling snapshot

• Question: Was the termination caused by an ineligible trust shareholder inadvertent?
• Outcome: Approved, conditioned on the corporation and shareholders reporting consistently with continued S status.
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, 1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200840003
Third Party Communication: None
Release Date: 10/3/2008
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:B02
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PLR-100230-08
Date: JUNE 27, 2008

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

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

Trust = ---------------------------------
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A = -------------------------
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B = --------------------
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Dear -------------------:

This responds to a letter dated December 14, 2007, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

X made an election to be treated as an S corporation. X’s election was inadvertently terminated effective Date 1 when Trust, an ineligible S corporation shareholder, became the owner of X stock. X discovered this problem on Date 2 and shortly thereafter transferred the X stock owned by Trust to A and B, the income beneficiaries of the trust. A and B are each individuals and eligible S corporation shareholders. X represents that the termination was 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 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
PLR-100230-08
2

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 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 that the termination of X’s S corporation election on Date 1 was inadvertent within the meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 1 and thereafter, provided X’s S corporation election was valid and provided that the election was not otherwise terminated under § 1361(d).

This ruling is conditioned upon the shareholders of X including in income their pro rata share of the separately stated and nonseparately computed items of X as provided in § 1366, making any adjustments to basis as provided in § 1367, and taking into account any distributions made by X as provided in § 1368. For this purpose, A and B, as the current income beneficiaries of Trust, shall be treated as the shareholders of X with respect to the stock of X held by Trust, beginning Date 1. If X or its shareholders fail to treat themselves as described above, this letter ruling shall be 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.
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Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s authorized representatives.

Sincerely,

J. Thomas Hines
Chief, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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