PLR 200323042: Late trust election treated as inadvertent S corporation termination

Plain-English summary

An estate transferred S corporation shares to a trust intended to be a qualified subchapter S trust, but the trust's beneficiary did not file the required election on time. That omission terminated the corporation's S election 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 its original election date. The relief requires the beneficiary to file a trust election effective on the transfer date within 60 days of the letter and the parties to treat the corporation consistently with the ruling. The IRS did not decide whether the corporation or trust otherwise met all eligibility requirements.

Ruling snapshot

• Question: Could S corporation status continue despite the beneficiary's late trust election?
• Outcome: Approved relief for an inadvertent termination, subject to a 60-day filing condition.
• Key authorities: IRC §§ 1361(d), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Number:200323042 Washington, DC 20224
Release Date: 6/6/2003
Index Number: 1362.04-00 Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:2 - PLR-163042-02
Date:
March 10, 2003

X =

Trust =

A =

B =

C =

D =

E =

F =

G =

H =

Estate =

D1 =

D2 =

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D3 =

Year 1 =

Year 2 =

State =

Accountants =

Dear
:

This letter responds to a letter dated November 14, 2002, and subsequent correspondence, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated under the laws of State on D1. X elected to be an S corporation effective D2. On D3, Estate transferred shares of X to Trust. Following the transfer, the shareholders of X were Trust, A, B, C, D, E, F, G, and H. A, X’s president, represents that Trust was intended to be a qualified subchapter S trust (“QSST”). However, no QSST election was timely filed on behalf of Trust. Therefore, X’s S election terminated on D3. Trust distributed all its income as required by § 1361(d)(3)(B). Trust’s beneficiary reported her allocable share of X’s income consistent with the treatment of Trust as a QSST.

In Year 1, Accountants became X’s accounting firm. In Year 2, Accountants discovered that no QSST election was timely filed on behalf of Trust. A represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent.

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 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.

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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 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)(A) provides that an election under § 1362(a) will be terminated whenever (at any time on or after the 1st day of the 1st 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 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 corporation election terminated on D3, under § 1362(d)(2) of the

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Code, because the beneficiary of Trust failed to timely file an election under
§ 1361(d)(2).

We further conclude that the termination of X’s S election was an inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as an S corporation effective D2 and thereafter, provided X’s election to be an S corporation was not invalid and provided that the election was not otherwise terminated under § 1362(d). In addition, from D3 and thereafter, Trust will be treated as a QSST described in § 1361(d)(3), and the beneficiary of Trust will be treated, for purposes of § 678, as the respective owner of the X stock held by Trust, provided that the beneficiary of Trust files a QSST election effective for D3 for Trust with the appropriate service center within 60 days following the date of this letter. If Trust, X, or its shareholders fail to treat X as described above, this ruling shall be null and void. A copy of this letter should be attached to the QSST elections.

Except as specifically ruled above, we express no opinion concerning the Federal tax consequences of the transactions described above under any other provision of the Code. Specifically, no opinion is expressed on whether X is otherwise eligible to be treated as an S corporation or whether Trust is an eligible QSST under § 1361(d)(3).

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

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

Sincerely yours,

CAROLYN HINCHMAN GRAY
Senior Counsel, Branch 2
Associate Chief Counsel
(Passthroughs and Special Industries)

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