PLR 200212011: Corporation receives relief for an inadvertent S election termination

Plain-English summary

A corporation’s S election was treated as terminated because two shareholder trusts did not timely make the required qualified subchapter S trust elections. The corporation had continued filing returns as an S corporation and represented that the failure was an oversight without tax avoidance intent. The IRS found the termination inadvertent and allowed the corporation to be treated as an S corporation from the original effective date, provided both trusts filed valid QSST elections within 60 days and the corporation and shareholders made required adjustments. The ruling did not decide whether the original S election was valid or whether the trusts otherwise qualified as QSSTs.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment after the trusts’ missed QSST elections caused an inadvertent termination?
• Outcome: Approved, subject to timely QSST elections and the conditions in the letter.
• Key authorities: IRC §§ 1361(c), 1361(d), 1362(d)(2), 1362(f), 1366, 1367, 1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200212011
Washington, DC 20224
Release Date: 3/22/2002
Index Number: 1362.04.-00
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:PLR-141645-01
Date:
Dec 17 2001

Legend:

X
=

Date 1 =

Date 2 =

Trust 1 =

Trust 2 =

This responds to your letter dated July 31, 2001, written on behalf of X, requesting a written determination on inadvertent termination relief under section 1362(f) of the Internal Revenue Code.

Facts

According to the information submitted in the ruling request and representations made therein, X was incorporated on Date 1. At that same time, X also made a S election, effective Date 2, that was accepted by the applicable Service Center. X recently obtained new accountants, who discovered that valid elections to be treated as a qualified subchapter S trust (“QSST”) were never filed by either Trust 1 or Trust 2. Due to this oversight, Trust 1 and Trust 2 did not make a timely QSST election under section 1362(d)(2), thereby terminating X’s S corporate election. Since Date 2 , X has continuously filed returns in accordance with a valid S election and QSST rules. When X’s new accountants discovered the oversight, X submitted this private letter ruling request.

X represents that the failure to file the QSST elections were not motivated by tax avoidance or retroactive tax planning. Further, X represents that from Date 2 until the present that X and all other shareholders of X have filed, or will file, returns consistent with X’s status as a S corporation. X and its shareholders have agreed to make any adjustments that the Commissioner may require consistent with the treatment of X as 2

an S corporation.

Law and Analysis

Section 1361(a)(1) defines a 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 1362(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 a 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 3

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.

Conclusion

Based solely on the facts submitted and representations set forth above, we conclude that (1) X’s S corporation election was terminated on Date 2; (2) the termination was inadvertent within the meaning of section 1362(f); (3) no later than a reasonable time after the 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 2 and thereafter, assuming X’s S corporation election is valid and not otherwise terminated under section 1362(d). However, this ruling in contingent on the beneficiary(s) of Trust 1 and Trust 2 filing a QSST election, with an effective date of Date 2, 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 filed both Trust 1 and Trust 2.

If both Trust 1 and Trust 2 files a valid QSST election, both trusts will be treated as a trust described in section 1361(c)(2)(A)(i), and the beneficiary(s) will be treated under section 678 as the owner(s) of the portion of Trust 1 and Trust 2 consisting of stock during the period from Date 2 and thereafter, assuming both Trust 1 and Trust 2 satisfy 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 section 1367, and take into account any distributions made by X to shareholders under section 1368. If X, 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 valid under section 1362, or whether Trust 1 and Trust 2 qualify as QSSTs within the meaning of section 1361(d)(3). 4

This ruling is directed only to the taxpayer(s) requesting 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,
Dianna K. Miosi
Chief, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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