Someone Dies…Do Not Forget Deadlines for the Subchapter-S Election!

Many entities are used for estate planning and for business operations. Often a corporation elects to be taxed a Subchapter S (“Sub-S”) corporation because of favorable taxation as a “pass through” entity instead of a “regular” corporation. Being taxed as a “regular” corporation can result in double taxation. The Sub-S election requirements are strict and only certain individuals and trusts can be shareholders of a Sub-S corporation. When a shareholder of a Sub-S corporation dies, you have to be sure the deadlines for the Sub-S election are met or the shareholder can face disastrous income tax consequences. A recent private letter ruling (“PLR”) ruled favorably for a taxpayer.

In PLR 201604009, the decedent taxpayer (“TP”) owned shares of a Sub-S corporation through his revocable trust (likely the shares were titled “TP, as trustee of the TP Revocable Trust”). When TP died, his revocable (now irrevocable) trust (Trust 1) held the shares. Upon TP’s death, under Section 1361(c)(2)(A)(iii) of the Internal Revenue Code (the “Code”), a revocable trust can be the owner of Sub-S shares for only 2 years after the death of the TP. No election was ever made within such 2 year period.

After that time, the trustee of Trust 1 distributed the shares (now not qualified Sub-S shares) to another trust, Trust 2 (for which a Sub-S election was never made), which then distributed the shares outright to the beneficiary who then transferred the shares to the beneficiary’s own revocable trust.

As the election to be taxed as a Sub-S corporation was not made within the appropriate time periods for either Trust 1 or Trust 2, the shareholder-beneficiary asked for relief.

Section 1362(f) of the Code provides that, if the Internal Revenue Service (the “Service”) determines that the Sub-S election was terminated because the termination was (1) inadvertent; (2) no later than a reasonable time after discovery the corporation actually qualifies as a small business corporation, and (3) the corporation and each shareholder agree to make any adjustments, then the corporation would be treated as a Sub-S corporation during such period.

Fortunately for this taxpayer and his or her advisor, the Service agreed and determined that the termination was inadvertent and if the proper documentation was provided to the Service within 120 days of the date of the PLR, the Sub-S election would not be terminated for any period.

ADVICE: While it is not clear as to who caused the error, it is important that, upon a taxpayer’s death, the personal representative, the trustee, the beneficiary and the advisor clearly mark on their calendar the 2 year time frame. PLRs are only binding on the taxpayer requesting them and it is now very expensive to obtain a PLR. Nevertheless this PLR is favorable and indicate that the Service will rule favorably in these circumstances.

WORD OF THE WEEK: GSTT (generation skipping transfer tax). The GSTT is a tax on transfers to grandchildren and other individuals or trusts who are or could benefit 2 generations or more below your generation. This is in ADDITION to the gift tax and the estate tax, making all taxes over 80%!!!! The good news is that there is now an exemption of $5.450 million dollars so most individuals will not face this tax. However, the use of this large GSTT exemption makes planning very important, as such planning can benefit many future generations.


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