PLR 200433017: Missed trust election treated as inadvertent S corporation termination

Plain-English summary

After a shareholder died, company stock passed through a trust to two other trusts. One trust needed a qualified subchapter S trust election, but its beneficiary did not file one on time, terminating the company's S corporation election. The omission came to light while an accountant prepared trust returns, and the trust later transferred its shares to eligible shareholders. The IRS found the termination inadvertent under section 1362(f) and allowed the company to continue as an S corporation. That treatment depended on consistent tax reporting and a QSST election effective on the transfer date filed within 60 days of the ruling.

Ruling snapshot

• Question: Could the company retain S corporation status after a trust beneficiary missed the QSST election deadline?
• Outcome: Approved: the termination was inadvertent, subject to the stated election and reporting conditions.
• Key authorities: IRC §§ 1361(d), 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200433017
Release Date: 08/13/2004
Index Number: 1362.04-00

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Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B02 – PLR-171095-03
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Date:
April 22, 2004

X = --------------------------------------------------------------------
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Trust 1 = -----------------------------------------------------------------------------------------------

Trust 2 = ---------------------------------------------------------------

Trust 3 = ---------------------------------------------------------------

Trust 4 = --------------------------------------------------------------------------------------------
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Trust 5 = -----------------------------------------------------------------------------------------------
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Trust 6 = -----------------------------------------------------------------------------------------------
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A = ------------------------------

B = -----------------------

D1 = ----------------------

D2 = -------------------

D3 = -----------------------

D4 = ---------------------

D5 = ----------------------

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D6 = -----------------------

State = ---------------

Year = -------

Dear ------------:

This letter responds to your letter, dated November 19, 2003, and subsequent correspondence, submitted on behalf of X as X’s authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X, incorporated under the laws of State, elected to be an S corporation effective D1. A was the sole shareholder of X from D2 until ---- death on D3. Following A’s death, pursuant to A’s will, all of the stock of X was transferred to Trust 1 on D4. Pursuant to the terms and provisions of Trust 1, the stock of X was transferred in equal portions to Trust 2 and Trust 3 on D5. Trust 2 is a trust, all of which is treated under § 678 as owned by B and, as such, is a qualified S corporation shareholder. B, X’s president, represents that Trust 3 was eligible to be a qualified subchapter S trust (“QSST”). However, no QSST election was timely filed on behalf of Trust 3. Therefore, X’s S election terminated on D5. The beneficiary of Trust 3 reported ---- allocable share of X’s income consistent with the treatment of Trust 3 as a QSST.

While preparing the Year tax returns for Trust 2 and Trust 3, X’s accountant discovered that no QSST election was timely filed on behalf of Trust 3. On D6, Trust 3 transferred its shares of X to Trust 4, Trust 5, and Trust 6, each of which is a trust, all of which is treated under §§ 676 and 678 as owned by B and, as such, is a qualified S corporation shareholder.

B represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make such adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary.

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.

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Section 1361(b)(1)(B) provides that the term “small business corporation” is a domestic corporation which is not an ineligible shareholder and which 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(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

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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 D5, under § 1362(d)(2), because the beneficiary of Trust 3 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 continuing to be an S corporation from D5 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). All of X’s shareholders in determining their respective income tax liabilities for the period beginning D5 and thereafter, must include their pro rata share of the separately stated and non-separately stated 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. Additionally, from D5 to D6, Trust 3 will be treated as a QSST described in § 1361(d)(3), and the beneficiary of Trust 3 will be treated as the owner of the X stock held by Trust 3 provided that the beneficiary of Trust 3 files a QSST election effective D5 for Trust 3 with the appropriate service center within 60 days following the date of this letter. If Trust 3, X, or X’s 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 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 is otherwise eligible to be treated as an S corporation, or whether Trust 3 is an eligible QSST under § 1361(d)(3).

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 a power of attorney on file with this office, a copy of this letter is being sent to X.

Sincerely,

J. Thomas Hines
Chief, Branch 2
Associate Chief Counsel
(Passthroughs & Special Industries)

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