PLR 1037001: IRS restored an S corporation election after trust shareholder changes

Plain-English summary

The IRS ruled that an S corporation election terminated when two trusts holding the corporation's shares were not eligible shareholders. The IRS found the termination inadvertent because the corporation represented that it had treated the trusts as qualified subchapter S trusts and had filed returns consistently with S corporation status. The corporation was treated as an S corporation from the termination date onward, and the two trusts were treated as QSSTs from that date, subject to one required election. The ruling also required the corporation and shareholders to apply the normal pass-through and distribution rules and stated that the relief would be void if they failed to do so.

Ruling snapshot

• Question: Could the corporation receive relief after trust shareholder changes terminated its S election?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, 1368, and 6110; Treas. Reg. § 1.1361-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201037001 Third Party Communication: None
Release Date: 9/17/2010 Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.04-00
Person To Contact:
------------------------- ------------------------, ID No. ------------------
---------------------------- ----------------------------------------------------
---------------------------- Telephone Number:
-------------------------------- ---------------------
Refer Reply To:
CC:PSI:B3
PLR-101207-10
Date:
June 08, 2010

                                                   Legend

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

Y = --------------------------------

State = ------

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

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

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

D = ----------------------------

E = ----------------

F = ---------------

Trust A = -------------------------------------------------------------------------

PLR-101207-10 2

Trust B1 = -------------------------------------------------------------------------------------

Trust B2 = -----------------------------------------------------------------------------------------

----------------------------------------------------

Trust C = -----------------------------------------------------------------------------------------

Trust D = ------------------------------------------------------------------

Trust E = -----------------------------------------

Trust F = ----------------------------------------

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

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

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

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

Date 5 = --------------------------

Year a = -------

Year b = -------

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

  This letter responds to a letter dated December 30, 2009 and subsequent

correspondence, submitted on behalf of X by its authorized representative, requesting
inadvertent termination relief under § 1362(f) of the Internal Revenue Code (Code).
PLR-101207-10 3

                                     FACTS

  X (f/k/a Y) was incorporated under the laws of State and elected to be an S

corporation on Date 1. On Date 1, Trust A and Trust B1, both revocable grantor trusts,
owned shares of X.

  A died in Year a. Subsequently, A’s shares of X were transferred to Trust B2.

On Date 2, B elected, and received, QSST status for Trust B2.

   On Date 3, B died. On Date 4, shares of X owed by Trust B1 and Trust B2 were

transferred to Trust C and Trust D. The income beneficiaries of Trust C and Trust D, C
and D respectively, did not make QSST elections. X represents that Trust C and Trust
D each qualified as a QSST.

    In Year b, C died. On Date 5, the shares of X owned by Trust C were transferred

to Trust E and Trust F, and Trust C terminated. On Date 5, Trust E and Trust F made
QSST elections. Subsequently, the shares of X owned by Trust E and Trust F were
distributed to their respective beneficiaries, E and F.

    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 Date 4, X has treated each separate and individual trust as an
effective QSST, 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.

                                      LAW

   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) defines the term “small business corporation” to be a

domestic corporation which is not an ineligible corporation and which does not (A) have
more than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more
than 1 class of stock.
PLR-101207-10 4

   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(d)(1) provides that, in the case of a QSST with respect to which a

beneficiary makes an election under § 1361(d)(2), (A) the trust shall be treated as a
trust described in § 1361(c)(2)(A)(i), (B) for purposes of § 678(a), the beneficiary of the
trust shall be treated as the owner of that portion of the trust which consists of stock in
an S corporation with respect to which the election under § 1361(d)(2) is made, and (C)
for purposes of applying §§ 465 and 469 to the beneficiary of the trust, the disposition of
the S corporation stock by the trust shall be treated as a disposition by such beneficiary.

    Section 1361(d)(2)(A) provides that a beneficiary of a qualified subchapter S trust

(or his legal representative) may elect to have § 1361(d) apply.

    Section 1361(d)(2)(D) provides that an election under § 1361(d)(2) will be

effective up to 15 days and 2 months before the date of the election.

    Section 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current

income beneficiary of a QSST must make the election under § 1361(d)(2) by signing and
filing with the service center with which the corporation files its income tax returns the
applicable form or statement including the information listed in § 1.1361-1(j)(6)(ii).

    Section 1361(d)(3) provides that the term “qualified subchapter S trust” means a

trust, (A) the terms of which require that (i) during the life of the current income
beneficiary, there shall be only one income beneficiary of the trust, (ii) any corpus
distributed during the life of the current income beneficiary may be distributed only to
such beneficiary, (iii) the income interest of the current beneficiary in the trust shall
terminate on the earlier of the beneficiary’s death or the termination of the trust, and (iv)
upon the termination of the trust during the life of the current income beneficiary, the
trust shall distribute all of its assets to that beneficiary, and (B) all of the income (within
the meaning of § 643(b)) of which is distributed (or required to be distributed) currently
to one individual who is a citizen or resident of the United States.

  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)(A) provides that an election under § 1362(a) shall be

terminated whenever (at any time on or after the first day of the first taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation. Section 1362(d)(2)(B) provides that a termination of an S
corporation election under § 1362(d)(2) is effective on or after the date of cessation.PLR-101207-10 5

    Section 1362(f) provides, in part, 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) or § 1361(b)(3)(C), (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 such ineffectiveness or
termination, 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 for which the
election was made or the termination occurred, and each person who was a shareholder
in 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 shall be treated as an S corporation during the period specified by the
Secretary.

                                     CONCLUSION

    Based solely on the facts submitted and the representations made, we conclude

that X’s S corporation election terminated on Date 4 because Trust C and Trust D were
not eligible shareholders of X. We also conclude that the termination of X’s S election
on Date 4 was an inadvertent termination within the meaning of § 1362(f). Accordingly,
pursuant to the provisions of § 1362(f), X will be treated as an S corporation from the
period from Date 4 and thereafter, provided that X’s S corporation election was valid
and was not otherwise terminated under § 1362(d). Trust C and Trust D will each be
treated as a QSST from Date 4 and thereafter. This ruling is contingent upon D filing an
election effective Date 4 for Trust D to be a QSST. This election must be filed within 60
days of the date of this letter with the appropriate service center. A copy of this letter
should be attached to the QSST election.

    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 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.

  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.
PLR-101207-10 6

     In accordance with the power of attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

   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 request for a ruling, it is subject to verification on examination.

                                    Sincerely,

                                     /s/

                                    Leslie H. Finlow
                                    Senior Technician Reviewer, Branch 3
                                    (Passthroughs and Special Industries)

Enclosures (2)
Copy of this letter
Copy for section 6110 purposes