S corporation receives relief after stock passed to an ineligible trust

Plain-English summary

Two shareholders transferred S corporation stock to a trust they intended to qualify as an eligible shareholder. The trust instrument did not cause the trust to be treated as wholly owned by them for federal tax purposes, so the trust was ineligible and the corporation's S election terminated. The trust later transferred the shares to another trust represented to be eligible. The corporation had continued to file as an S corporation, allocated the trust's items to the two individuals as if they held the shares directly, and represented that the failure was inadvertent and unrelated to tax avoidance or retroactive planning. The IRS granted Section 1362(f) relief and treated the corporation as continuously maintaining S status from the termination date, assuming its election was otherwise valid.

Ruling snapshot

• Question: Could the corporation preserve S status after its shares were temporarily held by an ineligible trust?
• Outcome: Approved
• Key authorities: IRC §§ 1361(b) and (c)(2), and 1362(d)(2) and (f)

Full text (IRS public release)

  Internal Revenue Service                                       Department of the Treasury
                                                                 Washington, DC 20224

  Number: 202140005                                              [Third Party Communication:
  Release Date: 10/8/2021                                        Date of Communication: Month DD, YYYY]
  Index Number: 1362.00-00, 1362.04-00
                                                                 Person To Contact:
  --------------                                                 ----------------------, ID No. ------------------
  ---------------------------------------------------            Telephone Number:
  ------------------------------------------------               -------------------
  --------------------------------------                         Refer Reply To:
                                                                 CC:PSI:B3
                                                                 PLR-101702-21
                                                                 Date:
                                                                 July 8, 2021




                                                        Legend

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

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

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

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

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

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

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

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



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

This letter responds to a letter dated January 18, 2020, 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 (Code).
                                              2
PLR-101702-21


                                           Facts

The information submitted states that X was incorporated under the laws of State on Date
1 and X elected to be an S corporation effective Date 1.

On Date 2, A transferred shares of X to Trust. A and his wife, B, intended that Trust
qualify as an eligible S corporation shareholder under § 1361(c)(2)(A)(i). However,
pursuant to the terms of Trust’s trust instrument, Trust was not treated as wholly owned
by A and B for federal income tax purposes. As a result, X’s S corporation election
terminated on Date 2.

On Date 3, Trust took remedial action and transferred its shares in X to a trust that X
represents is an eligible shareholder under § 1361(c)(2)(A)(i).

X represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent and not motivated by tax avoidance or retroactive tax
planning. X further represents that since Date 1, X has filed all returns consistent with
X’s status as an S corporation and the items of X attributable to Trust have been
allocated to A and B as though A and B owned the X shares directly. X and its
shareholders have agreed to make any adjustments the Commissioner may require,
consistent with the treatment of X as an S corporation.

                                     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 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.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 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 any termination under § 1362(d)(2)(A) is 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 was terminated under paragraph (2) or (3) of § 1362(d), (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
termination, steps were taken so that the corporation is once more a small business
corporation, and (4) the corporation and each person who was a shareholder of the
                                              3
PLR-101702-21


corporation at any time during the period specified pursuant to § 1362(f), agrees to make
any adjustments (consistent with the treatment of the corporation as an S corporation) as
may be required by the Secretary with respect to the period, then, notwithstanding the
circumstances resulting in the termination, the corporation will be treated as continuing to
be an S corporation during the period specified by the Secretary.

                                        Conclusion

Based solely on the information submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 2 when the X stock was transferred to
Trust. We further conclude that the termination was inadvertent within the meaning of
§ 1362(f). Accordingly, under § 1362(f), X will be treated as continuing to be an S
corporation on and after Date 2, provided that X’s S corporation election was valid and
not otherwise terminated under § 1362(d).

Except as specifically ruled above, we express or imply no opinion as to the federal
income 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.

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.

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.

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to X’s authorized representative.


                                       Sincerely,



                                       Adrienne M. Mikolashek
                                       Chief, Branch 3
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)



Enclosures (2)

        Copy of Letter
        Copy for 6110 purposes


cc: