As most everyone knows, only certain types of persons/entities may be S Corporation shareholders. Typical shareholders include individuals and revocable grantor trusts. In addition, estates and other types of trusts are also eligible subject to various restrictions. One concern that everyone has is avoiding the situation where it is determined there is an ineligible shareholder that would operate to terminate the S election. I recently ran across a number of Private Letter Rulings (“PLRs”) that permit additional flexibility in certain situations to expand the pool of eligible shareholders. PLRs 200008015, 200107025, 200439027 and 200816002 all held under differing factual situations that interjecting one or more disregarded entities for federal income tax purposes to own the shares between the individual and the S corporation would not cause termination of the S election.
None of the PLRs really disclosed the particular reasons for the structuring of share ownership in the manner described in each PLR. But the PLRs had factual situations ranging from (a) the simple scenario where a limited liability company owned the shares of the corporation and the individual owned 100% of the limited liability company; (b) a more complex scenario where the individual had a limited partnership own the shares and a limited liability company he owned was the general partner and the individual owned the limited partnership interest; and (c) an even more complex scenario where the S corporation shares were owned by (i) an intentionally defective grantor trust established by the individual and (ii) a partnership, which was in turn owned by (x) the individual, (y) a grantor retained annuity trust owned by the individual and (c) a limited liability company owned by (x1) the individual and (y1) another intentionally defective grantor trust. The IRS ruled in each situation that the intervening entities all constituted disregarded entities so that a termination of the S election in each scenario would not occur.
The factual scenarios also differed in that in one scenario only one of several shareholders was engaging in this planning while in other scenarios all of the shareholders were so planning. Obviously, implementing this type of planning would require vigilant monitoring to make sure no unintended disqualifying transfers occurred along the way.
Where such planning might be useful is in scenarios where internal family estate planning is beneficial for one or more, but not all, shareholders without upsetting the existing equilibrium with the other shareholders.
Michael W. Margrave