Temporary partnership owner causes only inadvertent S termination

Plain-English summary

An S corporation was owned through a disregarded limited liability company. The individual owner transferred part of the LLC to a grantor trust, then died, causing the trust to lose grantor-trust status and the LLC to become a partnership with both the trust and estate as owners. Because a partnership is not an eligible S corporation shareholder, the S election terminated on the date of death. The LLC later redeemed the estate's interest and again became a disregarded entity owned by the trust. The IRS found the termination inadvertent and treated the corporation as continuously maintaining S status, assuming the election was otherwise valid.

Ruling snapshot

• Question: Could the corporation retain S status after its sole owner temporarily became a partnership following the shareholder's death?
• Outcome: approved
• Key authorities: IRC §§ 1361(b)(1)(B), 1361(c)(2), 1362(d)(2), and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201730002 Third Party Communication: None
Release Date: 7/28/2017 Date of Communication: Not Applicable
Index Numbers:1362.00-00, 1362.01-00,
1362.04-00 Person To Contact:
-----------------------, ID No. -------------------
-------------------------------- ---------------------------------------------------
--------------------------------------------- Telephone Number:
---------------------------- --------------------
--------------------------------------- Refer Reply To:
CC:PSI:B3
PLR-101480-17
Date:
April 24, 2017

                                                  Legend

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

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

Y = --------------------------------------

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

N = ----

Estate = --------------------------------------

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

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

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

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

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

Date 5 = ---------------------------
PLR-101480-17 2

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

   This letter responds to a letter dated December 16, 2016, and subsequent

correspondence, submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code (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 1. On Date 2, A, the sole
shareholder of X, transferred A’s entire interest in X to Y, a limited liability company
wholly owned by A and treated as a disregarded entity for federal tax purposes. On
Date 3, A transferred a n% interest in Y to Trust, a grantor trust that was treated (under
subpart E of part I of subchapter J of chapter 1) as entirely owned by A. Trust was an
eligible shareholder under §1361(c)(2)(A)(i). On Date 4, A died, causing Trust to cease
being a grantor trust. On Date 4, X’s S corporation election terminated as Y, the sole
owner of X, became a partnership for federal tax purposes, an ineligible shareholder.
On Date 5, Y redeemed the shares of Estate (which were received by Estate at A’s
death), causing Y to be treated as a disregarded entity owned by Trust for federal tax
purposes.

   X represents that the termination event was not motivated by tax avoidance or

retroactive tax planning. X and its shareholders agree to make any adjustments that 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 such year.

   Section 1361(b)(1)(B) provides that the term “small business corporation” means

a domestic corporation that is not an ineligible corporation and that does not, among
other requirements, 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 subpart E of part I of subchapter J of Chapter 1) as owned
by an individual who is a citizen or resident of the United States, may be an S
corporation shareholder.
PLR-101480-17 3

   Section 1361(c)(2)(A)(ii) provides that, for purposes of § 1362(b)(1)(B), a trust

which is described in § 1361(c)(2)(A)(i) immediately before the death of the deemed
owner and which continues in existence after such death may be an S corporation
shareholder, but only for the 2-year period beginning on the date of the deemed owner’s
death.

  Section 1362(a)(1) provides that, except as provided in § 1362(g), a small

business corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

    Section 1362(d)(2)(A) provides that an election under § 1362(a) is terminated

whenever (at any time on or after the first day of the first 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 that if (1) an election under § 1362(a) or

§ 1361(b)(3)(B)(ii) by any corporation (i) 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 (ii) was terminated
under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (2) the Secretary determines that the
circumstances resulting in such ineffectiveness or termination were inadvertent; (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
such ineffectiveness or termination, steps were taken so that the corporation for which
the election was made or the termination occurred is a small business corporation or a
QSub, as the case may be, or to acquire the required shareholder consents; and (4) the
corporation for which the election was made or the termination occurred, and each
person who was a shareholder of the corporation at any time during the period specified
pursuant to § 1362(f), agree to make the adjustments (consistent with the treatment of
the corporation as an S corporation or a QSub, as the case may be) as may be required
by the Secretary with respect to this period, then, notwithstanding the circumstances
resulting in such ineffectiveness or termination, the corporation shall be treated as an S
corporation or a QSub, as the case may be, during the period specified by the
Secretary.

    Section 1.1362-4(b) of the Income Tax Regulations provides, in relevant part,

that for purposes of § 1.362-4(a), the determination of whether a termination was
inadvertent is made by the Commissioner. The corporation has the burden of
establishing that under the relevant facts and circumstances the Commissioner should
determine that the termination was inadvertent. The fact that the termination was not
reasonably within the control of the corporation or was not part of a plan to terminate the
election, or the fact that the terminating event or circumstances took place without the
knowledge of the corporation, notwithstanding its due diligence to safeguard itself
PLR-101480-17 4

against such an event or circumstance, tends to establish that the termination was
inadvertent.

   Section 1.362-4(d) provides, in relevant part, that the Commissioner may require

any adjustments that are appropriate. In general, the adjustments should be consistent
with the treatment of the corporation was an S corporation during the period specified
by the Commissioner.

                                    Conclusion

   Based solely on the facts submitted and representations made, we conclude that

X’s S corporation election terminated on Date 4. We further conclude that the
circumstances resulting in the termination on Date 4 were inadvertent within the
meaning of § 1362(f). Accordingly, under § 1362(f), X will be treated as an S
corporation from Date 4, provided X’s S corporation election was otherwise valid and
has not otherwise terminated under § 1362(f).

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the facts described above under any other provision of
the Code, including whether X was otherwise a valid S corporation.

   This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

of the Code provides that it may not be used or cited for precedent.

   Pursuant to a power of attorney on file, we are sending a copy of this letter to X’s

authorized representative.

   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 rulings requested, it is subject to verification on examination.

                                  Sincerely,

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

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