PLR 200453006: Missing trust election treated as inadvertent S corporation termination

Plain-English summary

An S corporation's stock passed from a deceased shareholder's estate to a trust that intended to qualify as a qualified subchapter S trust (QSST). The trust beneficiary did not file a timely QSST election, which terminated the corporation's S election. The IRS found that termination inadvertent under IRC § 1362(f) and ruled that the corporation could be treated as continuing as an S corporation. Relief required the beneficiary to file a QSST election effective on the stock distribution date within 60 days of the ruling letter and required consistent tax treatment by the trust, corporation, and shareholders. The IRS did not decide whether the trust or corporation otherwise met their eligibility requirements.

Ruling snapshot

• Question: Could the corporation retain S status despite the missing QSST election?
• Outcome: Approved, conditioned on a timely QSST election and consistent tax treatment.
• 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: 200453006
Release Date: 12/31/2004
Index Numbers: 1362.04-00

• Person To Contact:
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  --------------------------- Telephone Number:
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  Refer Reply To:
  CC:PSI:2 – PLR-129043-04
  Date:
  August 16, 2004

Legend

X = -----------------------
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A = -----------------------------------
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B = ---------------------
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C = -------------------------
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D = -----------------------------
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E = ------------------------------
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F = ------------------
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G = --------------------------------
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H = -----------------------------

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Trust = -----------------------------
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State = -------------------

d1 = --------------------------

d2 = ------------------

d3 = ------------------

d4 = ------------------

Dear -------------

This responds to a letter dated March 18, 2004, submitted on behalf of X by its authorized representative, requesting relief pursuant to § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated under the laws of State, with A as the sole shareholder. X elected to be an S corporation effective d1. On d2, A died. Between d1 and d2, a portion of X shares were transferred to B, C, D, E, F, G, and H through inter vivos gifts. On d3, A’s estate distributed the remaining shares of X, held by A’s estate, to Trust and C. Trust intended to meet the requirements of 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. B, the beneficiary of Trust reported B’s allocable share of X's income consistent with the treatment of Trust as a QSST on all affected returns. In d4, B met with an attorney to discuss B’s estate plan and discovered that no QSST election had been filed. Shortly thereafter, this request was made.

X 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

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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) provides that the term "small business corporation" means a domestic corporation which is not an ineligible corporation 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) -- (A) such trust shall be treated as a trust described in § 1361(c)(2)(A)(i) and, (B) 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

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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), because of the failure of the beneficiary of the trust to a file QSST election, and that this 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 d3 and thereafter, provided X's S corporation election was valid and was not otherwise terminated under section 1362(d). All of X's shareholders in determining their respective income tax liabilities during the termination period and thereafter, must include their pro rata share of the separately stated items of income (including tax-exempt income), loss, deduction, or credit and non-separately stated computed items of income or loss 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, during the termination period and thereafter, Trust will be treated as a QSST described in § 1361(d)(3) (assuming it otherwise qualifies as a QSST), and B will be treated as the owner of the X stock held by Trust, provided that B files a QSST election effective d3 with the appropriate service center within 60 days following the date of this letter. If Trust, 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 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 eligible to be a QSST under § 1361(d)(3).

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This ruling letter is directed only to the taxpayer who requested it. Section 6110(k)(3) 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 and X's authorized representative.

Sincerely,

Carolyn Hinchman Gray
Senior Counsel, Branch 2
Associate Chief Counsel
(Passthroughs and Special Industries)

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

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