October 1998 Issue


In a recent private letter ruling, the IRS ruled that a deemed sale under IRC section 338(h)(10) of stock held by a qualified subchapter S trust, or QSST, is taxable to the trust and not to the beneficiary. Under the facts of the ruling, two trusts acquired stock in an S corporation and filed the election to be treated as QSSTs. By making this election, the trusts are deemed to be revocable trusts, whereby all income is taxed directly to the beneficiaries.

Later all of the corporation's shareholders agreed to transfer their stock to a publicly traded corporation. As part of the transaction, the shareholders agreed to make an election under IRC section 338(h)(10) which enabled the acquiring corporation to have a step-up in the basis of the S corporation's assets. By making the 338(h)(10) election, the shareholders of the S corporation were deemed to have sold their stock for cash.

The IRS ruled that such a deemed sale of stock is one of the situations under Treas. Reg. section 1.1361-1(j)(8) where the QSST and not the beneficiaries are to be treated as the owner of the stock. The resulting gain, then, is taxable to the trust. *

Source: LTR 9828006.

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