PLR 200246017: Missed QSST election treated as inadvertent S corporation termination

Plain-English summary

An S corporation’s stock was transferred to a trust whose beneficiary did not file the qualified subchapter S trust election on time. The missed election caused the corporation’s S status to terminate when the trust became a shareholder. The IRS found the termination inadvertent under section 1362(f) and allowed the corporation to be treated as an S corporation from that date onward, assuming its original election was valid and no other termination occurred. The relief required the beneficiary to file a QSST election with the transfer date as its effective date within 60 days of the ruling and attach a copy of the letter. The IRS did not decide whether the trust otherwise met QSST requirements.

Ruling snapshot

• Question: Could the corporation retain S status after its trust shareholder’s beneficiary missed the QSST election?
• Outcome: Approved conditionally: inadvertent termination relief with a QSST election due within 60 days.
• Key authorities: IRC §§ 1361(d), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200246017
Washington, DC 20224
Release Date:11/15/2002
Index Number: 1362.04-00
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:B01-PLR-129871-02
Date:
Aug 9 2002

X
=

A
=

Date 1 =

Date 2 =

Date 3 =

Trust =

Dear
:

This responds to your letter dated May 20, 2002, 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 organized in Date 1, and elected to be treated as an S corporation effective Date 2. Since Date 2 X has 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, A, 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). Pursuant to section 1362(f), X will be treated as continuing to be an S corporation from Date 3 and thereafter, assuming X’s S corporation election is valid and not otherwise terminated under section 1362(d). This ruling is contingent on 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.

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.

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Pursuant to a power of attorney on file with this office, a copy of this letter is being sent to the taxpayer and the second listed authorized representative.

Sincerely,

/s/ Carolyn H. Gray

Carolyn H. Gray
Acting Assistant to the Branch Chief, Branch 1 Office of the Associate Chief Counsel
(Passthroughs and Special Industries)

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