GAIN FROM S CORP'S DEEMED SALE IS QSST'S, NOT BENEFICIARY'S.

Index Number.: 1361.03-02

[1] This responds to a letter dated October 6, 1998, and subsequent correspondence, submitted by your authorized representative requesting certain rulings under section 1361 of the Internal Revenue Code.

FACTS

[2] Company was incorporated on d1, and elected S corporation treatment on d2, effective for the taxable year beginning d3. Following the death of A on d4, Trust received shares of Company's stock. Subsequently, B, the income beneficiary of Trust, filed an election under section 1361(d)(2) to have Trust treated as a qualified subchapter S trust (QSST). The beneficiary reported all pass-through items of income, deduction, and credit allocable to the shares of Company's stock held by Trust.

[3] On d5, all of the shareholders of Company (including Trust) agreed to sell all of their shares of Company stock to Purchaser, a publicly traded C corporation. The transaction closed d6. As part of the stock purchase agreement, Purchaser and the shareholders of Company made an election under section 338(h)(10). It is represented that the corporate gain from the deemed sale of Company's assets resulting from the section 338(h)(10) transaction is approximately z.

RULING REQUESTED

[4] The taxpayers request a ruling that the corporate and shareholder gain on the deemed sale of assets resulting from a section 338(h)(10) election that is allocable to shares of S corporation stock held by Trust is that of Trust, and not of the income beneficiary of the QSST.

LAW AND ANALYSIS

[5] Section 1361(d)(1)(B) provides that for purposes of section 678(a), the beneficiary of a QSST is treated as owner of that portion of the trust which consists of stock in an S corporation with respect to which the QSST election is made.

[6] Section 1.1361-(j)(7) of the Income Tax Regulations provides that the income beneficiary who makes the QSST election and is treated (for purposes of section 678(a)) as the owner of that portion of the trust that consists of S corporation stock is treated as the shareholder of purposes of sections 1361(b)(1), 1366, 1367, and 1368.

[7] Section 1.1361-1(j)(8) provides that if a valid QSST election is made, the income beneficiary is treated as owner, for purposes of section 678(a), of that portion of the trust that consists of the stock of the S corporation for which the QSST election was made. However, solely for purposes of applying the preceding sentence to a QSST, an income beneficiary who is a deemed section 678(a) owner only by reason of section 1361(d)(1) will not be treated as the owner of the S corporation stock in determining and attributing the federal income tax consequences of a disposition of the stock by the QSST. For example, if the disposition is a sale, the QSST election terminates as to the stock sold and any gain or loss recognized on the sale will be that of the trust, not the income beneficiary. Similarly, if a QSST distributes its S corporation stock to the income beneficiary, the QSST election terminates as to the distributed stock and the consequences of the distribution are determined by reference to the status of the trust apart from the income beneficiary's terminating ownership status under sections 678 and 1361(d)(1). The portions of the trust other than the portion consisting of S corporation stock are subject to subparts A through D of subchapter J of chapter 1, except as otherwise required by subpart E of the Code.

[8] Section 1.338(h)(10)-1(a) provides that if a section 338(h)(10) election is made, the target corporation is generally deemed to sell all of its assets and distribute the proceeds in complete liquidation.

[9] Section 1.338(h)(10)-1(d) provides that a section 338(h)(10) election may be made for a target corporation if a purchasing corporation acquires the target corporation in a qualified stock purchase from S corporation shareholders.

[10] Under section 1.1361-(j)(8), any gain or loss on the sale of S corporation stock is reported by a QSST rather than the QSST beneficiary. As part of the stock purchase agreement, Purchaser and the shareholders of Company made a section 338(h)(10) election. Consequently, under section 338(h)(10), Company is deemed to sell all of its assets and distribute the proceeds in complete liquidation. A gain or loss resulting from a section 338(h)(10) election is one of the tax consequences of a disposition of stock by the QSST for which the QSST beneficiary is not treated as the owner of stock. Therefore, any gain or loss resulting from an election under section 338(h)(10) is allocated to the QSST as owner of the stock who reports all tax consequences relating to a stock sale under section 1.1361-1(j)(8).

CONCLUSION

[11] After applying the relevant law to the facts submitted and the representations made, we rule that Company's gain from the deemed sale of Company's assets resulting from a section 338(h)(10) election that is allocable to the shares of Company's stock held by Trust is that of Trust and not the beneficiary.

[12] Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the Code. Specifically, no opinion is expressed or implied concerning whether Company's S corporation election was valid, whether Trust is a QSST under section 1361(d), or on the validity of the section 338(h)(10) election.

[13] This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

                                   Sincerely yours,