PLR 200309019: Missed trust election receives inadvertent S termination relief

Plain-English summary

After a shareholder died, S corporation stock moved from one trust to a second trust. The second trust's beneficiary missed the qualified subchapter S trust election deadline, terminating the corporation's S election. The IRS found the termination inadvertent and ruled that the corporation could continue to be treated as an S corporation if the beneficiary filed a QSST election within 60 days. The letter says the corporation's continued S treatment begins on Date 3 but requires the election to be effective as of Date 4; it does not explain that difference. The IRS did not decide whether the original S election was valid or whether the second trust actually qualified as a QSST.

Ruling snapshot

• Question: Can the corporation retain S treatment after its trust beneficiary missed the QSST election deadline?
• Outcome: Approved, conditioned on filing a QSST election within 60 days with the effective date stated in the letter.
• 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: 200309019
Washington, DC 20224
Release Date: 2/28/2003
Index Number: 1362.04-00 Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:B01-PLR-150589-02
Date:
Nov 21 2002

Legend

X
=

A
=

B
=

Date 1 =

Date 2 =

Date 3 =

Date 4 =

State =

Trust 1 =

Trust 2 =

Dear
:

This responds to your letter dated September 10, 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 incorporated in State on Date 1, and elected to be treated as an S corporation effective Date 2. Since Date 2 X has operated and filed returns as an S corporation. On Date 3, A, the grantor of Trust 1, died. Upon A’s death the corpus of Trust 1, including stock of X, was transferred to Trust 2. X represents that Trust 2 is a qualified subchapter S trust (a "QSST") as defined in section 1361(d)(3). Due to an oversight, Trust 2's beneficiary, B, 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.

X represents that the transfer of stock to Trust 2 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 B, the sole beneficiary of Trust 2 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 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, provided that B, the beneficiary of Trust 2, files a QSST election, with an effective date of Date 4, 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 2 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,

/s/ David R. Haglund

David R. Haglund
Senior Technician Reviewer, Branch 1
Office of the Assistant Chief Counsel
(Passthroughs and Special Industries

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