PLR 200840011: Trust ownership caused an inadvertent S election termination

Plain-English summary

A revocable trust owned stock in an S corporation and became irrevocable when one of its two settlors died. Two years after the death, the trust ceased to be an eligible S corporation shareholder, terminating the corporation's S election until the stock was distributed to the surviving spouse. The IRS found the termination inadvertent because it was not motivated by tax avoidance or retroactive planning and the parties agreed to required adjustments. It treated the corporation as an S corporation during the lapse and treated the surviving spouse as the shareholder, provided all parties consistently report the corporation's items, basis adjustments, and distributions.

Ruling snapshot

• Question: Was the S election termination caused by the trust's loss of eligible-shareholder status inadvertent?
• Outcome: Approved. The corporation retains S status if it and its shareholders follow the ruling's reporting conditions.
• 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: 200840011
Third Party Communication: None
Release Date: 10/3/2008
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B02
PLR-106602-08
Date:
June 17, 2008

X = -------------------------------------------------------------------------------------------------------
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A = -------------------------------------------------------------------------------------------------------
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B = --------------------------------

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

D1 = -------------------

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

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

D4 = ---------------------------

D5 = ---------------------------

D6 = --------------------------

D7 = --------------------------

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

This responds to a letter dated February 12, 2008, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.
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The information submitted states that X was incorporated on D1. Trust, a revocable trust created by spouses A and B, acquired stock of X on D2. X elected to be an S corporation effective D3. B died on D4 and Trust became irrevocable. X’s S corporation election terminated on D5, two years after D4. On D6, Trust distributed the X stock to A. Beginning D4, A has reported all items of income, loss, credit, and deduction associated with the X stock owned by Trust as if A owned the stock directly and Trust has not filed any federal income tax returns. X was liquidated by merger effective D7.

X represents that the termination of its S election 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 1361(a)(1) of the Code 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 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 is an eligible shareholder. Section 1361(c)(2)(A)(ii) provides that 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 an eligible shareholder, but only for the 2-year period beginning on the day of the deemed owner’s death.

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 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
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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 and representations submitted, we conclude that X’s S corporation election was terminated on D5 because of the failure of Trust to qualify as an eligible shareholder and that this termination was inadvertent within the meaning of § 1362(f).

We hold that, pursuant to the provisions of § 1362(f), X will be treated as an S corporation from D5 to D6, and thereafter, provided X was otherwise eligible to make an S corporation election and provided that any such election did not otherwise terminate under § 1361(d). A will be treated as the shareholder of X from D4 to D6. 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(k)(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 representative.

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