Two trust eligibility failures treated as inadvertent S terminations

Plain-English summary

An S corporation's shares remained in a former grantor trust for more than two years after the grantor's death, making that trust an ineligible shareholder and terminating the S election. The trustee later transferred the shares to a second trust that filed a qualified subchapter S trust election but did not satisfy the QSST terms until a later modification, creating another potential termination. The corporation represented that neither failure involved tax avoidance or retroactive tax planning and that it had consistently filed as an S corporation. The corporation and its shareholders also agreed to make any required adjustments. The IRS treated both trust eligibility failures as inadvertent and allowed continuous S corporation treatment from the first termination date forward, assuming the election was otherwise valid and had not terminated for another reason.

Ruling snapshot

• Question: Can the corporation retain S status after one trust exceeded its post-death eligibility period and a successor trust initially failed the QSST requirements?
• Outcome: approved
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d)(2), 1362(f)

Full text (IRS public release)

Internal Revenue Service                                    Department of the Treasury
                                                            Washington, DC 20224

Number: 201739007                                           Third Party Communication: None
Release Date: 9/29/2017                                     Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                            Person To Contact:
----------------------------------                          --------------------------, ID No. ----------------
---------------------------------                           -----------------
----------------------------                                Telephone Number:
 ------------------------------------                       ----------------------
                                                            Refer Reply To:
                                                            CC:PSI:B03
                                                            PLR-109007-17
                                                            Date:
                                                            June 27, 2017


Legend

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

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

Year                              =     -------

D1                                =     -----------------

D2                                =     ---------------------------

D3                                =     --------------------------

D4                                =     -------------------

D5                                =     -------------------

D6                                =     --------------------

D7                                =     -----------------

D8                                =     -----------------------

D9                                =     --------------------------

Shareholder                       =     -----------------------------------------------------------------------
                                        -----------------------------------

Income Beneficiary                =     -----------------------------------------------------------------------
PLR-109007-17                                  2

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

Trust1                    =       -----------------------------------------------------------------------
                                  ------------------------------------

Trust2                    =       -----------------------------------------------------------------------
                                  -------------------------------------


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

        This letter responds to a letter dated March 10, 2017, 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 organized under the laws of State in
Year and elected to be an S corporation effective D1. On D2 and D3, Shareholder
transferred shares of X to Trust1. Trust1 was a grantor trust until D4, when Shareholder
died. Trust1 continued to own shares of X until D6, a date that is more than two years
subsequent to Shareholder’s death. On D7, the trustee of Trust1 transferred its shares
of X to Trust2. On D8, Trust2 filed an election to be treated as a qualified subchapter S
trust (QSST). However, the terms of Trust2 did not meet the requirements to make an
election to be treated as a QSST until it was modified on D9.

       Because shares of X remained in Trust1 more than two years after Shareholder’s
death, Trust1 was no longer a permitted shareholder on D5. Therefore, on D5, X’s S
corporation election terminated. In addition, Trust2 was not a permitted shareholder on
D7, when shares of X were transferred to Trust2. Therefore, if X’s S corporation
election had not terminated on D5, it would have terminated on D7.

       X represents that the termination was not motivated by tax avoidance or
retroactive tax planning. X further represents that it has filed consistently as an S
corporation since D1. X and its shareholders have agreed to make any adjustments
that the Commissioner may require, consistent with the treatment of X as an S
corporation.

                                 LAW AND ANALYSIS

      Section 1362(a) 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.
PLR-109007-17                                 3

        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) provides that the term “small business corporation” means 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 one class of stock.

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

        Section 1361(c)(2)(A)(ii) provides that a trust that was described in
§ 1361(c)(2)(A)(i) immediately before the death of the deemed owner and that continues
in existence after the owner’s death may be a shareholder, but only for the two-year
period beginning on the day of the deemed owner’s death.

       Section 1361(d)(1) provides that a QSST whose beneficiary makes an election
under § 1361(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the
beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) of that
portion of the trust which consists of stock in an S corporation with respect to which the
election under § 1361(d)(2) is made.

       Section 1362(d)(2)(A) provides that an election under § 1362(a) will be
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, in relevant part, 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 the termination were inadvertent, (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
the termination, steps were taken (A) so that the corporation is a small business
corporation, 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 termination, the corporation will be
treated as an S corporation during the period specified by the Secretary.
PLR-109007-17                                4


                                     CONCLUSION

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on D5, and would have terminated again on
D7, because of its ineligible shareholders. We also conclude that the circumstances
resulting in the terminations were inadvertent within the meaning of § 1362(f).
Accordingly, under § 1362(f), X will be treated as an S corporation from D5 and
thereafter, provided X’s S corporation election was otherwise valid and has not
otherwise terminated under § 1362(d) for reasons not addressed in this letter.

       Except as specifically ruled above, we express or imply no opinion concerning
the federal tax consequences of the facts described above under any other provisions
of the Code. Specifically, we express no opinion regarding X’s eligibility to be an 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 as precedent.

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

                                          Sincerely,



                                          Brad Poston
                                          Senior Counsel, Branch 3
                                          Office of the Associate Chief Counsel
                                          (Passthroughs and Special Industries)
Enclosures (2):

       Copy of this letter
       Copy for § 6110 purposes


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