Corporation preserved S status after a trust held stock too long

Plain-English summary

After a shareholder died, the estate distributed S corporation shares to a trust that was temporarily eligible to hold them. The trust failed to transfer the shares to eligible shareholders before its permitted period expired, terminating the corporation's S election until it later distributed the stock to the beneficiaries. The corporation and shareholders continued filing consistently with S status, and the beneficiaries reported their shares of corporate tax items as though they directly held the stock during the gap. The IRS found that the termination was inadvertent under § 1362(f). It treated the corporation as an S corporation continuously from the termination date, provided the election was otherwise valid and not otherwise terminated.

Ruling snapshot

• Question: Could the corporation retain S status despite the trust's temporary period as an ineligible shareholder?
• Outcome: Approved as an inadvertent termination
• Key authorities: IRC §§ 1361(c)(2)(A)(iii) and 1362(f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201418015
Third Party Communication: None
Release Date: 5/2/2014
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:B03
PLR-130855-13
Date:
January 06, 2014

LEGEND

X = -------------------------------------------------------------------------------------------------
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Y = ------------------------

Trust = -------------------------------------------------------------------------------------------------
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State = ----------

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

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

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

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

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

Trust Beneficiaries = -------------------------------------------------------------------------------------------------
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Dear ---------------:

This letter responds to a letter dated January 31, 2013, and subsequent correspondence, submitted on behalf of X by X’s authorized representatives, requesting inadvertent termination relief pursuant to § 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 an S corporation effective Date 2.

Y, one of X’s shareholders, died on Date 3. On Date 3, following the administration of Y’s estate, Y’s estate distributed its shares in X to Trust. From Date 3 to Date 4, Trust was an eligible shareholder by reason of § 1361(c)(2)(A)(iii). However, Trust did not transfer the shares of X to an eligible shareholder prior to Date 4. Therefore, X’s S corporation election terminated on Date 4. On Date 5, Trust distributed the shares of X to Trust Beneficiaries.

X represents that the termination was not motivated by tax avoidance or retroactive tax planning. X further represents that from Date 4, X and its shareholders have filed all returns consistent with X’s status as an S corporation, and that, from Date 4 to Date 5, Trust Beneficiaries reported their proportionate shares of X’s items of income, loss, deduction or credit as if the shares of X stock had been held by Trust Beneficiaries directly. 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.

LAW AND ANALYSIS

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, (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 (A) 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
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the case may be) 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 or a QSub, as the case may be during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that the termination of X’s S corporation election on Date 4 was inadvertent within the meaning of § 1362(f). We further conclude that, pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date 4 and thereafter, provided that X’s S corporation election was otherwise valid and not otherwise terminated under § 1326(d).

Except as expressly provided herein, we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express or imply no opinion regarding 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) 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 representatives.

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,

Stacy L. Short
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes

cc: