PLR 200004024: Missed trust elections caused an inadvertent S termination

Plain-English summary

Stock in an S corporation was transferred to three trusts whose beneficiaries missed the deadline for qualified subchapter S trust (QSST) elections. The IRS concluded that the resulting termination of the corporation's S election was inadvertent, provided the corporation and shareholders filed returns consistent with S status after the transfer. It ruled that the corporation would be treated as continuing as an S corporation from the transfer date unless its election was otherwise terminated. The letter does not decide whether the original S election was valid or whether the trusts actually qualify as QSSTs.

Ruling snapshot

• Question: Was the S election termination caused by the missed trust elections inadvertent?
• Outcome: Approved: continued S treatment from the transfer date, conditioned on consistent returns and no other termination.
• Key authorities: IRC §§ 1361(d), 1362(f).

Full text (IRS public release)

Internal Revenue Service                        Department of the Treasury

Index Number:       1362.04-00                  Washington, DC 20224

Number: 200004024                               Person to Contact:
Release Date: 1/28/2000                         Telephone Number:

                                                Refer Reply To:
                                                CC:DOM:P&SI:1-PLR- 115583-99
                                                Date:
                                                October 28, 1999

Legend

X            =

Date 1       =

Date 2       =

Trust 1      =

Trust 2      =

Trust 3      =

      This responds to your letter dated September 17, 1999, and subsequent
correspondence, written on behalf of X, requesting a ruling that the termination of X’s S
corporation status was an inadvertent termination under section 1362(f) of the Internal
Revenue Code.

FACTS

       According to the information submitted, X was incorporated on Date 1.
Subsequent to incorporation, X made an S corporation election effective Date 1, that
was accepted by the applicable Service Center. X has always reported as an S
corporation. On Date 2, X stock was transferred to Trust 1, Trust 2 and Trust 3 (“the
Trusts”). X represents that each of the Trusts is a qualified subchapter S trust (a
"QSST") as defined in section 1361(d)(3). Due to an oversight, none of the Trusts’
beneficiaries made a timely QSST election under section 1362(d)(2), thereby
terminating X's S corporation election on Date 2. When X's counsel discovered the
oversight, X submitted this private letter ruling request.

       X represents that the failure of the Trusts’ beneficiaries to file QSST elections
was inadvertent. Moreover, X and its shareholders represent that, notwithstanding the
termination of X’s S corporation election, they have continued to treat X as an S
corporation and the shareholders and the income beneficiaries of the Trusts, have
included in gross income their allocable shares of X’s income and loss.

LAW AND ANALYSIS

       Section 1361(a)(1) defines an S corporation as a small business corporation for
which an election under section 1362(a) is in effect. Section 1361(b)(1) defines "small
business corporation" as a domestic corporation that is not an ineligible corporation and
that does not (A) have more than 75 shareholders, (B) have as a shareholder a person
(other than an estate, other than a trust described in section 1361(c)(2), and other than
an organization described in (c)(6)) who is not an individual, (C) have a nonresident
alien as a shareholder, and (D) have more than one class of stock.

        Section 1361(c)(2)(A)(i) provides that a trust, all of which is treated (under
subpart E of part I of subchapter J of chapter 1) as owned by an individual who is a
citizen or resident of the United States, may be a subchapter S corporation
shareholder.

        Section 1361(d)(1) states that a QSST whose beneficiary makes an election
under section 1361(d)(2) will be treated as a trust described in section 1361(c)(2)(A)(i),
and the QSST's beneficiary will be treated as the owner (for purposes of section 678(a))
of that portion of the QSST's S corporation stock to which the election under section
1361(d)(2) applies.

       Under section 1361(d)(2)(A), the beneficiary of a QSST may elect to have
section 1361(d) apply. Under section 1361(d)(2)(D), this election will be effective up to
15 days and two months before the date of the election.

     Under section 1362(d)(2), an election to be an S corporation will be terminated
whenever the corporation ceases to be a small business corporation.

       Section 1362(f) provides that a corporation is treated as continuing to be an S
corporation during the period specified by the Secretary if (1) an election under section
1362(a) by any corporation was terminated under paragraph (2) or (3) of section
1362(d), (2) the Secretary determines that the termination was inadvertent, (3) no later
than a reasonable period of time after discovery of the terminating event, steps were
taken so that the corporation is once more a small business corporation, and (4) the
corporation, and each person who was a shareholder of the corporation at any time
during the period specified pursuant to section 1362(f) , agrees to make any
adjustments (consistent with the treatment of the corporation as an S corporation) as
may be required by the Secretary with respect to that period.

       S. Rep. No. 640, 97th Cong., 2d Sess. 12-13 (1982), 1982-2 C.B. 718, 723-24,
in discussing section 1362(f) of the Code, provides, in part, as follows:

      If the Internal Revenue Service determines that a corporation’s
      subchapter S election is inadvertently terminated, the Service can waive
      the effect of the terminating event for any period if the corporation timely
      corrects the event and if the corporation and the shareholders agree to be
      treated as if the election had been in effect for such period.

      The committee intends that the Internal Revenue Service be reasonable
      in granting waivers, so that corporations whose subchapter S eligibility
      requirements have been inadvertently violated do not suffer the tax
      consequences of a termination if no tax avoidance would result from the
      continued subchapter S treatment. In granting a waiver, it is hoped that
      taxpayers and the government will work out agreements that protect the
      revenues without undue hardship to taxpayers . . . . It is expected that the
      waiver may be made retroactive for all years, or retroactive for the period
      in which the corporation again became eligible for subchapter S
      treatment, depending on the facts.

CONCLUSIONS

        Based solely on the facts submitted and representations set forth above, we
conclude that the termination of X’s subchapter S election on Date 2 was inadvertent
within the meaning of section 1362(f) provided that X and its shareholders have filed
returns consistent with X’s status as an S corporation since Date 2.

      Pursuant to section 1362(f), X will be treated as continuing to be an S
corporation from Date 2, and thereafter, unless X's election is otherwise terminated.

        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 on whether X's original election to be an S
corporation was a valid election under section 1362 or whether the Trusts are QSSTs
within the meaning of section 1361(d)(3).

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

       Pursuant to a power of attorney on file in this office, a copy of this letter will be
sent to your authorized representative.

                                           Sincerely,

                                           Signed/Daniel J. Coburn
                                           Daniel J. Coburn
                                           Assistant Branch Chief, Branch 1
                                           Office of the Assistant Chief Counsel
                                           (Passthroughs and Special Industries)

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