PLR 200526014: Missed trust elections treated as inadvertent S corporation termination

Plain-English summary

Shares of an S corporation passed through a shareholder's will to two trusts. Their beneficiary and advisers did not know they needed to file qualified subchapter S trust elections. When the trusts ceased to be eligible shareholders, the corporation's S election terminated. The IRS found the termination inadvertent under IRC § 1362(f) and allowed the corporation to be treated as continuing as an S corporation, subject to the ruling's conditions. The beneficiary had 60 days from the ruling date to file the trust elections effective on the termination date. The IRS did not determine whether the trusts actually met the QSST requirements.

Ruling snapshot

• Question: Can the corporation retain S corporation treatment after two shareholder trusts missed their QSST elections?
• Outcome: Approved as an inadvertent termination, conditioned on timely QSST filings and consistent tax treatment.
• Key authorities: IRC §§ 1361(c)(2), 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: 200526014
Third Party Communication: None
Release Date: 7/1/2005
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
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CC:PSI:B02
PLR-163046-04
Date:
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March 22, 2005

X = ----------------------------
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A = -----------------------
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B = --------------------

Trust 1= -------------------------------------
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Trust 2= -------------------------------
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Date 1= ----------------------

Date 2= -------------------

Date 3= ----------------------

Date 4= ----------------------

Date 5= ----------------------

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

This letter responds to a letter dated September 3, 2004, submitted on behalf of X by its authorized representative, requesting relief under ' 1362(f) of the Internal Revenue Code.

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A, the president of X, represents that an election was made for X to be an S corporation effective Date 1. B, a shareholder of X, died on Date 2. On Date 3, pursuant to the terms of B’s will, shares of X were transferred to Trust 1 and Trust 2. A, the beneficiary of Trust 1 and Trust 2, represents that Trust 1 and Trust 2 were intended to qualify as Qualified Subchapter S Trusts (QSSTs) and that A has filed A’s federal income tax returns consistent with the treatment of Trust 1 and Trust 2 as QSSTs effective Date 3. However, A did not know, and the accountants and attorneys advising A did not inform A, of the need to file the QSST elections required under § 1361(d)(2). On Date 4, the failure to file the QSST elections was discovered and this request for relief was prepared.

A represents that the failure to file the QSST elections was not motivated by tax avoidance or retroactive tax planning. 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.

Section 1361(a)(1) of the Code 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(c)(2)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust with respect to stock transferred to it pursuant to the terms of a will is a permitted shareholder, but only for the 2-year period beginning on the day on which stock is transferred to it.

Section 1361(d)(1) provides that in the case of a QSST for which a beneficiary makes an election under ' 1361(d)(2), the trust is treated as a trust described in ' 1361(c)(2)(A)(i), and for purposes of ' 678(a), the beneficiary of the trust shall be treated as the owner of that portion of the trust that 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 may elect to have that section apply.

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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 returns the applicable form or a statement including the information listed in ' 1.1361-1(j)(6)(ii).

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 the ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in the ineffectiveness or termination, steps were taken (A) so that the corporation is a small business corporation or (B) to acquire the shareholder consents; and (4) the corporation and each person who was a shareholder of 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 the ineffectiveness or termination, the corporation will be treated as an S corporation during the period specified by the Secretary.

Based solely on the facts submitted and the representations made, we conclude that Trust 1 and Trust 2 were eligible S corporation shareholders under § 1361(c)(2)(A)(i) until Date 5. We conclude further that X’s S corporation election terminated on Date 5 when Trust 1 and Trust 2 became ineligible S corporation shareholders and that the termination was inadvertent within the meaning of § 1362(f).

We further hold that, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 5 and thereafter, provided X’s S corporation election was otherwise valid and provided that the election was not terminated under § 1361(d). Trust 1 and Trust 2 will be treated as trusts described in § 1361(c)(2)(A)(i), and A will be treated as the owner of the portion of each trust that consists of X stock. The shareholders of X must include their pro-rata share of the separately stated and nonseparately computed items of X as provided in § 1366, make any adjustments to basis as provided in § 1367, and take into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat themselves as described above, this ruling is null and void.

This ruling is conditioned upon A filing appropriately completed QSST elections for Trust 1 and Trust 2 effective Date 5, with the appropriate service center within 60 days following the date of this letter. A copy of this letter should be attached to the election.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the

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Code. In particular, we express no opinion on whether Trust 1 and Trust 2, are, or ever were, QSSTs within the meaning of § 1361(d)(3).

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

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

Sincerely,

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

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