PLR 200843030: Ineligible trust and partnership owners did not end S status

Plain-English summary

An S corporation’s election terminated when an ineligible trust acquired its stock after a shareholder’s death. The stock was later treated as owned through successive family beneficiaries and then transferred to a limited liability company taxed as a partnership, another ineligible shareholder. After an auditor identified the problem, the partnership transferred the shares to an eligible individual. The corporation represented that both ownership failures were inadvertent, all returns had consistently treated it as an S corporation, and the parties would make any required adjustments. The IRS granted § 1362(f) relief and continued S corporation treatment, assigning stock ownership to the relevant individuals for each period. It did not decide whether the original S election was otherwise valid.

Ruling snapshot

• Question: Could the corporation retain S status after its shares passed through an ineligible trust and partnership?
• Outcome: Approved. Both termination events were inadvertent, subject to the represented return treatment and any required adjustments.
• Key authorities: IRC §§ 1361(b), 1362(d), 1362(f)

Full text (IRS public release)

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Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 200843030 Third Party Communication: None
Release Date: 10/24/2008 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00 --------------------, ID No. -------------
Telephone Number:
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--------------------------------------------------- Refer Reply To:
----------------------------------- CC:PSI:B02
---------------------------- PLR-144202-07
-------------------------------------- Date:
July 01, 2008

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B = -----------------------------------------------------------------------------------------------------
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C = -----------------------------------------------------------------------------------------------------
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E = ----------------------------

Trust1 = -----------------------------------------------------------------------------------------------------
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Trust2 = -----------------------------------------------------------------------------------------------------
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D1 = -----------------------------------------------------------------------------------------------------
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D2 = -----------------------------------------------------------------------------------------------------
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D3 = ----------------------

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PLR-144202-07 2

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

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

  This responds to a letter dated August 24, 2007, and subsequent

correspondence submitted on behalf of X by X’s authorized representative, requesting
inadvertent termination relief under § 1362(f) of the Internal Revenue Code.

     The information submitted states that X was incorporated under the laws of State

on D1 and elected to be an S corporation effective D2. Upon the death on D3 of A,
Trust2 became the owner of the X shares. Trust2 was an ineligible S corporation
shareholder and X’s S corporation election terminated on D3. From D3 to D4, B
reported the income of X as if Trust2 were a QSST. From D4 when B died to D5 when
X stock was transferred to a limited liability company, C (the child of A and B) reported
the income of X as if Trust2 were a QSST. Upon the death on D4 of B, X stock was to
be distributed to C under the terms of Trust1. An attorney advised C to place the X
shares in a limited liability company. On D5, shares of X were transferred to E, a limited
liability company taxed as a partnership. The income from the X stock passed through
to E was reported by C and her husband on a joint return. During an audit of X
beginning on D6, the auditor noted that the transfer of X stock to E caused the
termination of X’s S corporation election. To remedy this problem, on D7, E transferred
its X stock to C, an eligible S corporation shareholder. Consequently, X’s S corporation
election would have terminated on D5 due to the transfers of X stock to E, had the
election not already terminated on D3.

   X represents that the circumstances resulting in the termination of X’s S

corporation election were inadvertent and not motivated by tax avoidance. X further
represents that from D3, X and its shareholders have filed all returns consistent with X’s
status as an S corporation. X and its shareholders have agreed to make such
adjustments (consistent with the treatment of X as an S corporation) as may be required
by the Secretary.

    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 it was 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 such
ineffectiveness were inadvertent, (3) no later than a reasonable period of time after
discovery of the event resulting in the ineffectiveness, steps were taken (A) so that the
corporation is a small business corporation, or (B) to acquire the required 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 such ineffectiveness or termination, the
PLR-144202-07 3

corporation shall 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 X’s S corporation election terminated on D3, under § 1362(d)(2), when Trust2, an
ineligible shareholder, acquired X stock. We also conclude that this termination of X’s S
election on D3 was an inadvertent termination within the meaning of § 1362(f).
Moreover, had X’s S corporation election been valid, it would have terminated on D5
under § 1362(d)(2), when E, an ineligible shareholder, acquired X stock. Similarly, this
termination of X’s S election on D5 would have been an inadvertent termination within
the meaning of § 1362(f).

    Therefore, we conclude that X will continue to be treated as an S corporation for

the period from D3 and thereafter, provided that X’s S corporation election was valid
and was not otherwise terminated under § 1362(d). During the period from D3 to D4, B
will be treated as the owner of the X stock acquired by Trust2. During the period from
D4 to D5, C will be treated as the owner of the X stock acquired by Trust2. During the
period from D5 and thereafter, C will be treated as the owner of the X stock acquired by
E.

   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 regarding X’s eligibility to be an S
corporation or the validity of its S corporation election.

  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 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

cc:
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