Inadvertent S corporation termination receives relief

Plain-English summary

An S corporation's stock was held by a revocable trust that became ineligible to remain an S corporation shareholder after the grantor's death. The trustee and estate executor had not timely elected under IRC § 645 to treat the trust as part of the estate, and the trust's current beneficiaries were nonresident aliens. The IRS concluded that the resulting termination of the S election was inadvertent. It allowed the corporation to continue being treated as an S corporation if the trust disposed of the stock to an eligible shareholder, or the corporation liquidated, within 120 days. The trust and estate also had to file returns consistent with the required electing small business trust treatment for the relevant period.

Ruling snapshot

• Question: Could the corporation retain S status after an ineligible trust shareholder inadvertently terminated its election?
• Outcome: approved, subject to corrective action within 120 days
• Key authorities: IRC §§ 645, 1361, and 1362(f)

Full text (IRS public release)

Internal Revenue Service                                         Department of the Treasury
                                                                 Washington, DC 20224

Number: 201648006                                                Third Party Communication: None
Release Date: 11/25/2016                                         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:B03
                                                                 PLR-109428-16
                                                                 Date:
                                                                 August 24, 2016


LEGEND

X                 =         -------------------------------------------------
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Trust =            ----------------------------------------------------
----------------------------------------------------------
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Estate            =         ----------------------------------
----------------------------------------------------

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

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

Country1          =        -------------

Country2          =        ----------

Date1             =        -----------------

Date2             =        -----------------

Date3             =        ------------------------

Date4             =        -----------------

Date5             =        -----------------
PLR-109428-16                                 2




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

       This responds to a letter dated March 17, 2016, and subsequent
correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under §1362(f) of the Internal Revenue Code (the Code).

        The information submitted states that X was incorporated under the laws of State
on Date1. X elected to be an S corporation effective Date2. A established Trust as an
revocable trust on Date3 and transferred shares of X to Trust. X represents that Trust
was properly treated as a grantor trust for purposes of §§ 671-677 of the Code from
Date3 until Date4, when A died, and was an eligible S corporation shareholder during
this time pursuant to § 1361(c)(2)(A)(i). Trust continued to be an eligible S corporation
from Date4 until Date5, pursuant to § 1361(c)(2)(A)(ii). X further represents that Trust
would have been eligible to make an election under § 645(c) to be treated as a
“qualified revocable trust” as defined in § 645(b)(1) and treated as part of A’s estate
(“Estate”) until the “applicable date” described in § 645(b)(2), which is six months after
the date of the final determination of the liability for tax imposed by chapter 11. Such an
election would have permitted Trust to continue to be an eligible S corporation
shareholder from Date4 until the “applicable date” as described in § 645(b)(2).
However, the trustee of Trust and the executor of Estate failed to timely file the election
under § 645(c) to treat Trust as a qualified revocable trust.

       According to the submission, Trust did not fail any of the eligibility requirements
or restrictions provided in § 1361(e)(1)(A) and (B) in order to be an electing small
business trust (“ESBT”), except that the current beneficiaries of Trust are all non-
resident aliens residing in either Country1 or Country2.

       X represents that X and all of X’s shareholders have filed tax returns consistent
with X being an S corporation since Date2. Between Date4 and Date5, Trust and
Estate filed their tax returns consistent with the treatment of Trust as part of Estate. In
addition, X represents that Trust has filed its tax returns consistent with its treatment as
an ESBT since Date5 (with Estate treated as the sole beneficiary of Trust). X further
represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. 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.

      Section 1362(f) provides that if (1) an election under § 1362(a) by a 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
PLR-109428-16                                3

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 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.

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date5 as the result of Trust becoming an
ineligible S corporation shareholder on that date while owning X stock. We further
conclude that the termination of X’s S corporation election on Date5 was inadvertent
within the meaning of § 1362(f). We further hold that, pursuant to the provisions of
§ 1362(f), X will be treated as continuing to be an S corporation from Date5 and
thereafter, provided that X’s S corporation election was valid and provided that the
election was not otherwise terminated under § 1362(d).

        This ruling is contingent upon the trustee of Trust selling or otherwise disposing
of its X stock to an eligible S corporation shareholder within 120 days of the date of this
letter. This condition may also be satisfied by the liquidation and dissolution of X within
the 120 day period. In addition, Trust and Estate must file federal tax returns consistent
with Trust being treated as an ESBT, with Estate treated as its sole beneficiary, from
Date5 to the date of final disposition of its X stock.

       If the above conditions are not met, then this letter ruling is null and void.
Furthermore, if these conditions are not met, X must send a notification that its S
election has terminated as of Date5 to the service center with which X’s S election was
filed.

       Except as specifically set forth above, no opinion is expressed concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed regarding X’s eligibility to be an S
corporation or the validity of its S corporation election. Further, no opinion is expressed
as to whether Trust previously qualified as a grantor trust.

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

      The rulings contained in this letter are based upon information and
representations submitted by the taxpayer and accompanied by a penalty of perjury
PLR-109428-16                                4

statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

      In accordance with the power of attorney on file with this office, we are sending
copies of this letter to X’s authorized representatives.

                                      Sincerely,



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

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



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