S corporation status preserved after shares passed to ineligible trusts

Plain-English summary

An S corporation shareholder transferred shares to seven trusts that were not eligible S corporation shareholders, terminating the company's S election. After the problem was discovered, the trustee modified each trust agreement so the trusts could qualify as eligible shareholders under section 1361(c)(2)(A)(i). The company, its shareholder, and the trusts had filed returns consistently with continued S corporation treatment and agreed to make any adjustments required by the IRS. The IRS concluded that the terminations were inadvertent under section 1362(f). It treated the company as continuing to be an S corporation from the first termination date, provided the election was otherwise valid and had not terminated for another reason.

Ruling snapshot

• Question: Could the company retain S corporation treatment after shares were transferred to seven ineligible trusts?
• Outcome: approved
• Key authorities: IRC §§ 1361(b), 1361(c)(2)(A)(i), 1362(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service                                   Department of the Treasury
                                                           Washington, DC 20224

Number: 201750013                                          Third Party Communication: None
Release Date: 12/15/2017                                   Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
                                                           Person To Contact:
------------------------------------ --                    -----------------------, ID No. -------------------
--------------------------                                 ---------------------------------------------------
-------------------------------                            Telephone Number:
--------------------------------------------               --------------------
------------------------------                             Refer Reply To:
                                                           CC:PSI:B3
                                                           PLR-121544-17
                                                           Date:
                                                           September 05, 2017




Legend

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

State = ---------

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

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

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

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

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

Date 6 = -------------------

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

Trust 1 = -----------------------------------------------------------
-------------------------------------

Trust 2 = --------------------------------------------------------
-------------------------------------

Trust 3 = ------------------------------------------------------

PLR-121544-17                                          2

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

Trust 4 = --------------------------------------------------------
-------------------------------------

Trust 5 = ---------------------------------------------------------
-------------------------------------

Trust 6 = ------------------------------------------------------
-------------------------------------

Trust 7 = -----------------------------------------------------------
-------------------------------------

b         = ------------

c         = --------------

d         = -----

e         = -----


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

      This responds to a letter dated July 11, 2017, and subsequent correspondence,
submitted on behalf of X by its authorized representative requesting a ruling under
§ 1362(f) of the Internal Revenue Code (the Code).


                                                  FACTS

      X was organized on Date 1 as a corporation under the laws of State. Effective
Date 2, A became the sole shareholder of X. On Date 3, X elected to be treated as an
S corporation.

        On Date 4, A gifted b shares and sold c shares in X to each of Trust 1, Trust 2,
Trust 3, Trust 4, Trust 5, Trust 6 and Trust 7. In addition, on Date 5, A gifted d shares
and sold e shares in X to each of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and
Trust 7. However, Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and Trust 7 were
ineligible shareholders. As a result, X’s S corporation election terminated on Date 4.

       X was made aware of the termination of its S corporation status in connection
with a review of the trust agreements of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust

PLR-121544-17                                3

6 and Trust 7. As a result, on Date 6, the trustee modified the trust agreements of Trust
1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and Trust 7 to cause Trust 1, Trust 2, Trust
3, Trust 4, Trust 5, Trust 6 and Trust 7 to be eligible S corporation shareholders
pursuant to § 1361(c)(2)(A)(i) of the Code.

        X represents that X and its shareholders intended for X to be an S corporation
effective Date 3 and that X and Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and
Trust 7 have filed all returns consistent with X’s status as an S corporation since Date 3
and Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and Trust 7 have filed all returns
consistent with their status as eligible S corporation shareholders since Date 4. X and
its shareholders agree to make any adjustments required as a condition of obtaining
relief under the inadvertent termination rule as provided in § 1362(f) of the Code.

                                  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 the year.

       Section 1361(b)(1) defines a “small business corporation” as a domestic
corporation which is not an ineligible corporation which does not (A) have more than
100 shareholders, (B) have as a shareholder a person (other than an estate, and 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 one
class of stock.

       Section 1361(c)(2)(A)(i) provides in relevant part that a trust all of which is
treated (under subpart E of part I of subchapter J of Chapter 1 of the Code) as owned
by an individual who is a citizen or resident of the United States qualifies as a
shareholder pursuant to § 1361(b)(1)(B).

       Section 1362(d)(2)(A) provides than 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 corporation. Section 1362(d)(2)(B) further provides that the termination shall
be effective on and after the date of cessation.

        Section 1362(f) provides, in relevant 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), (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

PLR-121544-17                                4

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 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.


                                   CONCLUSION

       Based on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on Date 4 when A gifted b shares and sold c
shares of stock in X to each of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and
Trust 7. In addition, had X’s S corporation election not terminated on Date 4, X’s S
corporation election would have terminated on Date 5 when A gifted d shares and sold
e shares in X to each of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and Trust 7.
However, we conclude that such terminations were inadvertent within the meaning of
§ 1362(f). Therefore, X will be treated as continuing to be an S corporation from Date 4
and thereafter, provided X’s S corporation election was otherwise valid and, apart from
the inadvertent termination ruling described above, has not otherwise terminated under
§ 1362(d).

         Except as specifically ruled upon above, we express or imply no opinion
concerning the federal tax consequences of the facts described above under any other
provision of the Code. Specifically, we express or imply no opinion regarding X’s
eligibility to be an S corporation. Furthermore, no opinion is expressed or implied as to
whether Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and Trust 7 are valid grantor
trusts under § 1361(c)(2)(A)(i) or any federal tax consequences resulting from the
modification of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6 and Trust 7.

PLR-121544-17                                 5

      The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and is 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 this request, it is subject to verification on examination.

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

        Pursuant to a power of attorney on file with this office, we are sending copies of
this letter to your authorized representative.



                                              Sincerely,




                                              Bradford R. Poston
                                              Senior Counsel, Branch 3
                                              Associate Chief Counsel
                                              (Passthroughs and Special Industries)


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