PLR 200111018: Late trust election caused inadvertent S corporation termination

Plain-English summary

An S corporation's stock was transferred to a trust whose beneficiary did not timely file a qualified subchapter S trust (QSST) election. The IRS concluded that the corporation's S election terminated when the trust became an ineligible shareholder, but found the termination inadvertent under § 1362(f). It ruled that the corporation would be treated as continuing its S status from that date, provided its election was not otherwise terminated. The trust must file a valid QSST election, and the shareholders must report the corporation's items, basis adjustments, and distributions consistently with S corporation status. The ruling becomes void if the corporation or shareholders fail to use that treatment.

Ruling snapshot

• Question: Could the corporation retain S status after its trust shareholder missed the QSST election deadline?
• Outcome: Approved as inadvertent termination relief, subject to a valid QSST election and consistent tax reporting.
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Number: 200111018
Washington, DC 20224
Release Date: 3/16/2001
Index Number: 1362.04-00
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:2 - PLR-115373-00
Date:
December 12, 2000

X =

A =

Grantors =

Trust =

D1 =

D2 =

D3 =

Dear
:

This letter responds to a letter, dated July 20, 2000, and subsequent correspondence, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated on D1 and elected to be treated as an S corporation effective D2. On D3, Grantors transferred 6 shares of X stock to Trust. A is the sole income beneficiary of Trust. A represents that Trust is qualified under § 1361(d) to be a Qualified Subchapter S Trust (QSST). However, due to the oversight and misinterpretation of the election requirements by the trustees of Trust responsible for tax matters, the elections to treat Trust as a QSST was not timely filed.

A further represents that neither X nor any of its shareholders engaged in tax avoidance or retroactive tax planning and that X intended to maintain its status as an S corporation at all times.

X, and X’s shareholders agree to make any adjustments (consistent with the treatment of X as an S corporation) that the Secretary may require for the period of termination.
 -2-

Section 1361(a)(1) defines an "S corporation" as a small business corporation for which an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a "small business corporation" means a domestic corporation that is not an ineligible corporation and that does not have as a shareholder a person (other than an estate, a trust described in § 1361(c)(2), or an organization described in § 1361(c)(6)) who is not an individual.

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 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current income beneficiary of the trust must make the election under § 1361(d)(2) by signing and filing with the service center with which the corporation files its income tax return the applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).
Section 1362(d)(2) of the Code provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the first taxable year for which a corporation is an S corporation) such corporation ceases to be a small business corporation. A termination of an S corporation election under § 1362(d)(2) is effective on and after the date of cessation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2); (2) the Secretary determines that the circumstances resulting in such termination were inadvertent; (3) no later than a reasonable period of time after discovery of the circumstances resulting in the termination, steps were taken so that the corporation is a small business corporation; and (4) the corporation, and each person who was a shareholder of the corporation at any time -3-

during the period specified under section 1362(f), agrees to make the adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary for that period, then, notwithstanding the circumstances resulting in such termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.

Based solely on the facts and representations submitted, we conclude that X’s S corporation election terminated on D3 when Trust, an ineligible S corporation shareholder, acquired X stock. We also conclude that the termination was inadvertent within the meaning of § 1362(f).

We further hold that under the provisions of § 1362(f), X will be treated as continuing to be an S corporation on D3, and thereafter, provided that the election was not otherwise terminated under § 1362(d).

If Trust files a valid QSST election, Trust will be treated as a trust described in § 1361(c)(2)(A)(i), and A will be treated under § 678 as the owner of the portion of Trust consisting of X stock on D3, and thereafter, assuming Trust satisfies the QSST requirements. Accordingly, the shareholders of X must include their pro rata share of the separately stated and nonseparately computed items of X as provided in § 1366, make any adjustments to basis provided in § 1367, and take into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat X as described above, this ruling will be null and void.

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

In accordance with the power of attorney on file with this office, a copy of this letter is being sent to X’s authorized representatives.

Sincerely yours,
J. THOMAS HINES
Chief, Branch 2
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)
Enclosures: 2
Copy of this letter
Copy for § 6110 purposes