PLR 200024020: Inadvertent S corporation termination waived after missed trust election

Plain-English summary

A corporation's S election terminated when its stock was transferred to a trust and the trust beneficiary missed the election deadline for qualified subchapter S trust treatment. The IRS found the termination inadvertent and ruled under section 1362(f) that the corporation would continue to be treated as an S corporation from the transfer date. Relief was contingent on the beneficiary filing a trust election effective on that date within 60 days of the ruling, with a copy of the letter attached. The shareholders also had to report the corporation's tax items consistently; inconsistent treatment by the corporation, trust, or shareholders would void the ruling. The IRS did not decide whether the original S election was valid or whether the trust met the trust qualification rules.

Ruling snapshot

• Question: Can the corporation retain S treatment after an inadvertent termination caused by a missed trust election?
• Outcome: Approved, subject to the trust election, consistent tax treatment, and other stated conditions.
• Key authorities: IRC §§ 1361(c)(2), (d), 1362(d), (f), 1366 through 1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Index Number: 1362.04-00 Washington, DC 20224

Number: 200024020
Person to Contact:
Release Date: 6/16/2000
Telephone Number:

Refer Reply To:
CC:DOM:P&SI:1-PLR-104017-00
Date:
March 13, 2000

Legend

X
=

Date 1 =

Date 2 =

Date 3 =

Trust =

This responds to your letter dated February 11, 2000, and subsequent correspondence, written on behalf of X, requesting inadvertent termination relief 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 2 that was accepted by the applicable Service Center. X has always reported as an S corporation. On Date 3 X stock was transferred to Trust. X represents that Trust is a qualified subchapter S trust (a "QSST") as defined in section 1361(d)(3). Due to an oversight, Trust’s beneficiary did not make a timely QSST election under section 1362(d)(2), thereby terminating X's S corporation election on Date 3. When X's counsel discovered the oversight, X submitted this private letter ruling request.

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X represents that the transfer of stock to Trust and subsequent failure to file the QSST election were not motivated by tax avoidance or retroactive tax planning. Further, X represents that from Date 3 until the present that X, the sole beneficiary of Trust and all other shareholders of X have filed, or will file, returns consistent with X’s status as an S corporation. X and its shareholders have agreed to make any adjustments that the Commissioner may require consistent with the treatment of X as an S corporation.

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

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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 1) X’s S corporation election was terminated on Date 3; 2) the termination was inadvertent within the meaning of section 1362(f); 3) no later than a reasonable time after discovery of the terminating event steps were taken to acquire the required shareholder consents; and 4) no tax avoidance was intended or will result from the continued treatment of X as an S corporation. Therefore under section 1362(f), X will be treated as an S corporation from Date 3 and thereafter, assuming X’s S corporation election is valid and is not otherwise terminated under section 1362(d). However, this ruling is contingent of the beneficiary of Trust filing a QSST election, with an effective date of Date 3, with the appropriate service center within 60 days of the date of this ruling. A copy of this letter must be attached to the QSST election.

If Trust files a valid QSST election Trust will be treated as a trust described in section 1361(c)(2)(A)(i), and the beneficiary will be treated under section 678 as the owner of the portion of Trust consisting of X stock during the period from Date 3 and thereafter assuming Trust satisfies the QSST requirements. Accordingly, the shareholders of X must include their pro rata share of the separately and nonseparately computed items of X under section 1366, make any adjustments to stock basis under

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section 1367, and take into account any distributions made by X to shareholders under section 1368. If X, Trust, or any of X’s shareholders fail to treat X as described above, this ruling will be null and void.

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 Trust is a QSST within the meaning of section 1361(d)(3).

This ruling is directed only to the taxpayer that 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 with this office, a copy of this letter is being sent to the taxpayer.

Sincerely,

Signed/Dianna K. Miosi
Dianna K. Miosi
Chief, Branch 1
Office of the Assistant Chief Counsel
(Passthroughs and Special Industries

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