PLR 200543025: Missed trust election treated as inadvertent S status termination

Plain-English summary

An S corporation shareholder died, and shares passed under the will to a trust. The trust's beneficiary failed to elect qualified subchapter S trust (QSST) treatment, causing the company's S election to terminate when the trust became an ineligible shareholder. The IRS found the termination inadvertent and allowed the company to be treated as continuing its S status if the parties reported consistently and the beneficiary filed a completed QSST election within 60 days. The IRS did not decide whether the trust actually met all QSST requirements.

Ruling snapshot

• Question: Could the corporation retain S status after its trust shareholder missed the QSST election?
• Outcome: Approved, conditional on a QSST election and consistent tax treatment.
• Key authorities: IRC §§ 1361(c)(2), (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: 200543025
Third Party Communication: None
Release Date: 10/28/2005
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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--------------------, ID No. -------------
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Telephone Number:
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Refer Reply To:
CC:PSI:B02
PLR-117603-05
Date:
July 18, 2005
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X = ---------------------------------------
EIN: ----------------

A = -------------------

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

C = ---------------
SSN: -----------------

Trust = -------------------------------------------------------------------------------
EIN: ----------------

Date 1 = ------------------

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

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

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

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

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

This letter responds to a letter dated March 17, 2005, and subsequent correspondence 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 term of B’s will, shares of X were transferred to Trust. C, the beneficiary of Trust, failed to elect to treat Trust as a Qualified Subchapter S Trust (QSST). Therefore, on Date 4, X’s election to be an S corporation terminated. On Date 5, the failure to file the QSST election was discovered and this request for relief was prepared.

C represents that Trust’s failure to elect to be a QSST was inadvertent and was not motivated by tax avoidance or retroactive tax planning. Additionally, C represents that C has filed C’s federal income tax returns consistent with the treatment of Trust as a QSST effective Date 3. 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) 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.

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

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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 X’s S corporation election terminated on Date 4 when Trust became an ineligible S corporation shareholder 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 4 and thereafter, provided X’s S corporation election was otherwise valid and provided that the election was not otherwise terminated under § 1361(d). Trust will be treated as a trust described in § 1361(c)(2)(A)(i), and C will be treated as the owner of the portion of 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 C filing a completed QSST election for Trust effective Date 4, 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 Code. In particular, we express no opinion on whether Trust is, or ever was a QSST within the meaning of § 1361(d)(3).

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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