S corporation termination treated as inadvertent

Plain-English summary

An individual transferred shares of an S corporation to two trusts, one of which was not an eligible S corporation shareholder. The corporation's S election therefore terminated when the ineligible trust received its shares. After discovering the error, the trust promptly transferred all of its shares to the eligible trust. The IRS found the termination inadvertent and allowed the corporation to be treated as an S corporation continuously, provided its election had been valid and was not otherwise terminated.

Ruling snapshot

• Question: Will the corporation receive inadvertent-termination relief after shares were transferred to an ineligible trust?
• Outcome: approved
• Key authorities: IRC §§ 1361(b)(1)(B), 1361(c)(2), 1362(d)(2), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201652003 Third Party Communication: None
Release Date: 12/23/2016 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
-------------------------------------------- -----------------------, ID No. --------------
-------------------------- Telephone Number:
-------------------------- ----------------------
------------------------------- Refer Reply To:
CC:PSI:B01
PLR-109800-16
Date:
September 19, 2016

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

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

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

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

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

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

Date 2 = -----------------
------------------------------------------------------------------------------------------------------------------
Date 3 = -------

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

Dear -------------------

This letter responds to a letter dated January 25, 2016, and subsequent
correspondence, submitted on behalf of X, requesting relief under § 1362(f) of the
Internal Revenue Code.

Facts
PLR-109800-16 2

The information submitted states that X was formed under the laws of State on Date 1.
X filed a timely election under § 1362(a) to be taxed as an S corporation effective Date

2. As of Date 3, A, an individual, owned all of the shares of X stock. On Date 3, A
   contributed A’s shares of X stock to both Trust 1 and Trust 2. Trust 1 is an eligible
   shareholder of X pursuant to § 1361(c)(2)(A)(i); however, Trust 2 is an ineligible S
   corporation shareholder under § 1361(b)(1)(B). X represents that upon discovery of its
   error, it promptly took remedial action. Effective Date 4, Trust 2 transferred all of its
   shares of X stock to Trust 1.

X represents that the transfer of the X stock to Trust 2, an ineligible shareholder, was
not motivated by avoidance or retrospective tax planning. X and its shareholders have
continued to treat X as an S corporation at all times. X and its shareholders agree to
make any adjustments (consistent with the treatment of X as an S corporation) that the
Secretary may require.

Law

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which
an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a “small business corporation” means a domestic
corporation that is not an ineligible corporation and that does not 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.

Section 1361(c)(2)(A)(i) provides that, for the purposes of §1362(b)(1)(B), a trust all of
which is treated (under title 26, subtitle A, chapter 1, subchapter J, part I, subpart E of
the United States Code) as owned by an individual who is a citizen or resident of the
United States may be a shareholder of an S corporation.

Section 1362(d)(2) 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 a
corporation is an S corporation) such corporation ceases to be a small business
corporation. A termination of an S corporation election under § 1362(d)(2) is effective
on and after the date of cessation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was
terminated under § 1362(d)(2) or (3), (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 event resulting in the 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, 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
PLR-109800-16 3

corporation as an S corporation) as may be required by the Secretary with respect to
such period, then, notwithstanding the circumstances resulting in such ineffectiveness,
the corporation shall be treated as 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 3, when shares of X stock were
transferred to Trust 2, an ineligible shareholder. We also conclude that this termination
was inadvertent within the meaning of § 1362(f), and that under the provisions of
§ 1362(f), X will be treated as an S corporation from Date 3, and thereafter, provided
that X’s S election was valid and was not otherwise terminated.

Except for the specific ruling above, we express no opinion concerning the federal tax
consequences of the facts described above under any other provision of the Code.
Specifically, no opinion is expressed concerning whether X was 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.

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent
to X’s authorized representative.

                                    Sincerely,

                                    Laura C. Fields

                                    Laura C. Fields
                                    Senior Technician Reviewer, Branch 1
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

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

cc: