PLR 200042009: Missed trust elections receive inadvertent S termination relief

Plain-English summary

Two trusts bought shares of an S corporation, but their subscription agreements mistakenly described them as revocable grantor trusts. The trusts were intended to be qualified subchapter S trusts, and their beneficiaries had not timely filed the required elections. The IRS concluded that this ended the corporation's S election when the trusts acquired the stock, but that the termination was inadvertent under § 1362(f). It ruled that the corporation would be treated as an S corporation from that date onward if its original election was valid and no other termination occurred. The letter did not decide whether the trusts actually met the QSST requirements.

Ruling snapshot

• Question: Could the corporation retain S treatment after the trusts missed their QSST elections?
• Outcome: Approved: inadvertent termination relief, conditional on a valid original S election and no other termination.
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d)(2), 1362(f).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Number: 200042009
Washington, DC 20224
Release Date: 10/20/2000
Index Number: 1362.04-00
Person to Contact:

Telephone Number:

Refer Reply To:
CC:DOM:P&SI:2-PLR-101788-00
Date:
July 18, 2000
X =

Trust A =

Trust B =

A =

B =

Trustee =

State =

Date 1 =
Date 2 =
Date 3 =
Date 4 =
Date 5 =

Dear
:
This letter responds to your letter dated November 17, 1999, and subsequent correspondence, submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue Code.

The information submitted states that X is a corporation incorporated under the laws of State on Date 1. X elected to be an S corporation effective Date 2.

On Date 3, Trust A and Trust B each purchased one quarter of a share of X stock. On the subscription agreements between X and the Trustee of Trust A and Trust B, Trustee identified Trust A and Trust B as revocable grantor trusts.

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On Date 4, B, the beneficiary of Trust B, died. Pursuant to the terms of Trust B, Trust B terminated on Date 4 and the X stock held by Trust B was transferred to Trust A.

Following the death of the B, it was discovered that Trust A and Trust B were mistakenly identified on the subscription agreements. Trust A and Trust B were not revocable grantor trusts but were instead intended to be qualified subchapter S trusts (QSSTs) for which timely QSST elections were not made with respect to the X stock.

Upon discovering that QSST elections should have been, but were not made with respect to the X stock, a QSST election was submitted to the appropriate Internal Revenue Service Center for Trust A effective Date 5.

Trustee of Trust A and Trust B represents that Trust A and Trust B are QSSTs within §1362(d)(2) and that Trust A and Trust B have been administered as QSSTs since their inception. Moreover, A, the beneficiary of Trust A, represents that A has included in gross income Trust A’s allocable share of X’s income and loss. Trustee represents that Trustee, as B’s father, took responsibility for assuring that B included in gross income Trust B’s allocable share of X’s income and loss and that B did in fact include in gross income Trust B’s allocable share of X’s income and loss.

C, the president of X represents that X’s officers, directors, and advisors believed Trust A and Trust B were revocable grantor trusts and that they were unaware that QSST elections were required to be filed to qualify Trust A and Trust B as shareholders of X. Thus, the circumstances resulting in X’s termination were inadvertent. C represents further that the transfer of the X stock to Trust A and Trust B was not part of a plan to terminate X’s S election and that X and all of its shareholders have consistently treated X as an S corporation since Date 2. 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.

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1361(a)(1) provides that the term "S corporation" means, with respect to any taxable year, a small business corporation for which an election under § 1362(a) is in effect for such year.

Section 1361(b)(1)(B), as in effect for taxable years beginning on or before December 31, 1997, provided that a "small

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business corporation" cannot have as a shareholder a person (other than an estate, and other than a trust described in
§ 1361(c)(2)) who is not an individual.

Section 1361(c)(2)(A)(i) provides that for purposes of § 1361(b)(1)(B), 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 shareholder.
Section 1361(d)(1) provides that in the case of a qualified subchapter S trust (QSST) with respect to which a beneficiary makes an election under § 1361(d)(2), such trust shall be treated as a trust described in § 1361(c)(2)(A)(i) and, for purposes of § 678(a), the beneficiary of such trust shall be treated as the owner of that portion of the trust which consists of stock in an S corporation with respect to which the election under § 1361(d)(2) is made.

Section 1361(d)(2)(A) provides that a beneficiary of a QSST (or his legal representative) may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that an election under § 1361(d)(2) shall be effective up to 15 days and 2 months before the date of the election.
Section 1362(d)(2)(A) provides that an election under § 1362(a) will be terminated whenever (at any time on or after the 1st day of the 1 st taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation. Section 1362(d)(2)(B) provides that the termination shall be effective on and after the date of cessation.
Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation (A) was not effective for the taxable year for which made (determined without regard to § 1362(b)(2)) by reason of a failure to meet the requirements of § 1361(b) or to obtain shareholder consents, or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness or termination, steps were taken (A) so that the corporation is a small business corporation, or (B) to acquire the required shareholder consents, and (4) the corporation, and each person who was a shareholder in the corporation at any time during the period specified pursuant to § 1362(f), agrees to make such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in such ineffectiveness or termination, such corporation shall be treated

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as an S corporation during the period specified by the Secretary.

Based solely on the representations made and the information submitted, we conclude that X’s S election terminated on Date 3, under §1362(d)(2) of the Code, because the beneficiaries of Trust A and Trust B failed to timely file an election under § 1361(d)(2). We also conclude that the termination of X’s S election was an inadvertent termination within the meaning of § 1362(f).

We further hold that under the provisions of § 1362(f), X will be treated as an S corporation during the period Date 3 to Date 5 and thereafter, provided that X’s election to be an S corporation was valid and was not otherwise terminated under § 1362(d). From Date 3, Trust A will be treated as a trust described in § 1361(c)(2)(A)(i), and A will be treated as the owner of that portion of Trust A that consists of X stock. From Date 3 until B’s death on Date 4, Trust B will be treated as a trust described in § 1362(c)(2)(A)(i), and during that period B will be treated as the owner of that portion of Trust B that consists of X stock.
Except as specifically ruled above, we express no opinion concerning the federal income tax consequences of the transactions described above under any other provision of the Code, including whether Trust A and Trust B are QSSTs under § 1361(d)(3). This ruling letter is directed only to the taxpayer who requested it and may not be used of cited as precedent.

Pursuant to a power of attorney on file with this office, a copy of this letter is being sent to X.

Sincerely yours,
J. THOMAS HINES
Acting Branch Chief, Branch 2
Office of the Assistant Chief Counsel
(Passthroughs and Special Industries)

Enclosures: 2
Copy of this letter
Copy for section 6110 purposes

cc: