S corporation keeps status after shares briefly pass to an ineligible shareholder

Plain-English summary

An S corporation's election terminated when all of its shares were transferred to an ineligible shareholder. After discovering the problem, the ineligible shareholder transferred the shares in equal portions to an eligible individual and a trust, and the individual beneficiary made a qualified subchapter S trust election. The corporation represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive planning, and was corrected promptly. It also represented that all affected returns had consistently treated the corporation as an S corporation and that the corporation and shareholders would make any required adjustments. The IRS treated the corporation as continuously maintaining S status from the termination date forward, provided the election was not otherwise terminated.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after its stock was transferred to an ineligible shareholder and later moved to an individual and a QSST?
• Outcome: Approved: continuous S corporation treatment under section 1362(f).
• Key authorities: IRC §§ 1361 and 1362(f).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201811005 Third Party Communication: None
Release Date: 3/16/2018 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
----------------------------------------------------- ----------------, ID No. ------------------
----------------------------------------------------- Telephone Number:
-------------------------- --------------------
------------------------------------------ Refer Reply To:
CC:PSI:B01
PLR-119018-17
Date:
November 29, 2017

LEGEND

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

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

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

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

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

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

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

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

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

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

This responds to a letter dated June 8, 2017, and subsequent information, submitted on
behalf of X by X’s authorized representative, requesting relief under section 1362(f) of
the Internal Revenue Code (the Code).

PLR-119018-17 2

FACTS

According to the information submitted and representations made within, X was
incorporated on Date 1 under the laws of State, and made a valid S election effective on
Date 2.

On Date 3, all of the shares in X were transferred to Y, an ineligible shareholder, thus
causing X’s S corporation election to terminate. After the discovery of the terminating
event, Y took corrective action on Date 4 and transferred the X shares in equal
proportions to A, an eligible shareholder, and to Trust. A, the beneficiary of Trust, made
a Qualified Subchapter S Trust (QSST) election effective Date 4.

X represents that its S corporation election termination was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. Further, X represents that X
and its shareholders agree to make any adjustments required as a condition of
obtaining relief under the inadvertent termination rule as provided under § 1362(f) of the
Code that may be required by the Secretary.

X also represents that all income has been reported on all affected returns of X and all
of its shareholders consistent with the treatment of X as an S corporation, and that
neither X nor any of its shareholders intended to terminate its subchapter S election. In
addition, X represents that Trust qualifies as a QSST under section 1361(d) and has
qualified as a QSST since Trust acquired the X stock on Date 4. X represents that
other than the inadvertent termination, X has qualified as a small business corporation
at all times since its election on Date 2.

LAW AND ANALYSIS

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

PLR-119018-17 3

Section 1361(d)(1) provides that in the case of a QSST with respect to which a
beneficiary makes an election under § 1361(d)(2) the trust is treated as a trust
described in § 1361(c)(2)(A)(i) and, for purposes of § 678(a), the beneficiary of the trust
is treated as the owner 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 1361(d)(3) provides that the term “qualified subchapter S trust” means a trust
(A) the terms of which require that (i) during the life of the current income beneficiary,
there shall be only 1 income beneficiary of the trust, (ii) any corpus distributed during
the life of the current income beneficiary may be distributed only to such beneficiary, (iii)
the income interest of the current income beneficiary in the trust shall terminate on the
earlier of such beneficiary’s death or the termination of the trust, and (iv) upon the
termination of the trust during the life of the current income beneficiary, the trust shall
distribute all of its assets to such beneficiary, and (B) all of the income (within the
meaning of section 643(b)) of which is distributed (or required to be distributed)
currently to 1 individual who is a citizen or resident of the United States. A substantially
separate and independent share of a trust within the meaning of 663(c) shall be treated
as a separate trust for purposes of § 1361(d)(3) and § 1361(c).

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(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (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 such termination, steps were taken so that the corporation for
which the termination occurred is a small business corporation; and (4) the corporation
for which the termination occurred, and each person who was a shareholder in such
corporation at any time during the period specified pursuant to § 1362(f), agrees to
make the adjustments (consistent with the treatment of such corporation as an S
corporation) as may be required by the Secretary with respect to such period, then,
notwithstanding the circumstances resulting in such termination, such corporation shall
be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on Date 3. We further conclude that the
termination of X’s S election on Date 3 was inadvertent within the meaning of § 1362(f).
Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation as of Date 3 and thereafter, provided that X’s S corporation election is not

PLR-119018-17 4

otherwise terminated under § 1362(d).

Except as specifically ruled upon above, we express or imply no opinion concerning the
tax consequences of the facts of this case under any other provision of the Code.
Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation or whether Trust is otherwise a valid QSST.

This ruling is directed only to the taxpayer who requested it. According to section
6110(k)(3), this ruling may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,

                                   Joy C. Spies

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

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

cc: