PLR 1033028: IRS granted relief after an inadvertent S corporation termination

Plain-English summary

The IRS concluded that a corporation’s S corporation election terminated when a grantor trust continued to hold its stock beyond the two-year period allowed after the deemed owner’s death. The IRS also determined that the termination was inadvertent and granted relief under section 1362(f), allowing the corporation to be treated as an S corporation from the termination date onward, provided its election was otherwise valid. The corporation and its shareholders had to make consistent adjustments and report their pro rata shares of the corporation’s income, loss, deductions, credits, and distributions. The ruling was based on the taxpayer’s representations and did not address whether the corporation was otherwise eligible for S corporation treatment.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment after its election terminated because a trust remained a shareholder too long?
• Outcome: approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201033028 Third Party Communication: None
Release Date: 8/20/2010 Date of Communication: Not Applicable
Index Numbers: 1362.00-00, 1362.04-00
Person To Contact:
------------------ ----------------------, ID No. -------------
--------------- Telephone Number:
----------------------------------- ---------------------
------------------------------- Refer Reply To:
CC:PSI:B03
PLR-154765-09
Date: May 17, 2010

                                               LEGEND

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

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

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

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

Date = --------------------------
1
Date = --------------------------
2
Date = ----------------
3
Date = ----------------
4
Date = ---------------------
5

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

This letter responds to a letter dated December 1, 2009, 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.

                                                FACTS

The information submitted states that X was incorporated under the laws of State on
Date 1, and elected to be treated as an S corporation, effective Date 2. One of the
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shareholders of X was Trust, a grantor trust described in § 1361(c)(2)(A)(i) and
established by A. A died on Date 3. Trust qualified under § 1361(c)(2)(A)(ii) as an
eligible S corporation shareholder until Date 4, two years after A’s death. Trust,
however, continued to hold X stock until Date 5, when Trust distributed all of the X stock
to eligible S corporation shareholders. As such, X’s S corporation election terminated
on Date 4 when Trust ceased to be an eligible S corporation shareholder.

X represents that the circumstances resulting from the termination of X’s S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. X further represents that at all times since Date 4, X and its shareholders
have treated X as an S corporation. X and its shareholders agree to make any
adjustments (consistent with the treatment of X as an S corporation) as may be required
by the Secretary.

                              LAW AND ANALYSIS

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, for purposes of subchapter S, 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 of an S
corporation.

Section 1361(c)(2)(A)(ii) provides 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 the death, is a permitted shareholder, but only for the
2-year period beginning on the day of the deemed owner’s death.

Section 1362(a)(1) provides that, except as provided in § 1362(g), a small business
corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

Section 1362(d)(2) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 1st taxable year for which the
corporation is an S corporation) such corporation ceases to be a small business
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corporation. Any termination under § 1362(d)(2) is effective on and after the date of
cessation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was
terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the
circumstances resulting in such termination were inadvertent, (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, and (4) the corporation for which the termination
occurred, and each person who was a shareholder in such corporation at any time
during the period specified pursuant to § 1362(f), agrees to make such adjustments
(consistent with the treatment of such corporation as an S corporation) as may be
required by the Secretary with respect to such period, then, notwithstanding the
circumstances resulting in such termination, such corporation shall be treated as an S
corporation during the period specified by the Secretary.

                                 CONCLUSION

Based solely on the representations made and the information submitted, we conclude
that X’s S corporation election terminated on Date 4. We also conclude that the
termination of X’s S corporation election constituted an inadvertent termination within
the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be
treated as continuing to be an S corporation from Date 4 and thereafter, provided that
X’s S corporation election was otherwise valid and was not otherwise terminated under
§ 1362(d).

Accordingly, X’s shareholders, in determining their respective income tax liabilities
during the termination period and thereafter, must include their pro rata share of the
separately stated items of income (including tax-exempt income), loss, deduction, or
credit and non-separately computed items of income or loss 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 by § 1368. If X or any of the shareholders fail to
treat X as described above, this ruling shall be void.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed or implied concerning whether X is
otherwise eligible to be treated as an S corporation.

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

In accordance with a power of attorney on file with this office, we are sending a copy of
this letter to your authorized representative.
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The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

                                 Sincerely,

                                 /s/

                                 Tara P. Volungis
                                 Senior Technician Reviewer, Branch 3
                                 (Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes