PLR 200550016: Late trust elections receive inadvertent S termination relief

Plain-English summary

A shareholder transferred S corporation shares to two trusts for minor grandchildren, but their legal guardian did not make timely qualified subchapter S trust elections. The IRS found that this terminated the corporation's S election when the shares were transferred, but that the termination was inadvertent. It ruled that the corporation would continue to be treated as an S corporation from that date if the guardian files elections for both trusts, effective on the transfer date, within 60 days. The IRS did not decide whether the trusts actually qualify as QSSTs or whether the original S election was valid.

Ruling snapshot

• Question: Can the corporation retain S treatment after two trusts missed their QSST elections?
• Outcome: Approved as inadvertent termination relief, conditional on filing both trust elections within 60 days.
• Key authorities: IRC §§ 1361(d)(2), 1362(f); Treas. Reg. § 1.1361-1(j)(6)(iii)(E).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200550016
Release Date: 12/16/2005
Index Number: 1362.04-00

Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:2 – PLR-122108-05
Date:
August 17, 2005

Legend

X = ----------------------
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A = ---------------------------
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B = ------------------------------
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C = ----------------------------
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D = ------------------------

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

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

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

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

n = -----
 2

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

This responds to a letter dated March 17, 2005 submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

The information submitted states that X was organized on Date 1 and elected to be taxed as an S corporation effective Date 2. On Date 3, A, a shareholder of X, established Trust 1 and Trust 2 for the benefit of A’s minor grandchildren, B and C. On Date 4, A transferred n shares of X to Trust 1 and Trust 2. X represents that Trust 1 and Trust 2 are eligible to be Qualified Subchapter S Trusts (QSSTs). However, due to inadvertence, D, B and C’s parent and legal guardian, did not elect to treat Trust 1 and Trust 2 as QSSTs.

X represents that the transfer of stock to Trust 1 and Trust 2 and the subsequent failure to file the QSST election were not motivated by tax avoidance. Furthermore, X and all its shareholders represent that from Date 4 until the present, X, and the shareholders have all filed returns consistent with X's status as an S corporation. X and all its shareholders have agreed to make any adjustments that the Commissioner may require consistent wit the treatment of X as an S corporation.

LAW AND ANALYSIS

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 § 1362(c)(6)) who is not an individual.

Section 1361(c)(2)(A)(i) provides that 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 subchapter S corporation 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)(1)(2) will be treated as a trust described in § 1362(c)(2)(A)(i), and the QSST's beneficiary will be treated as the owner (for purposes of section 678(a)) of that portion of the QSST's S corporation stock to which the election under § 1361(d)(2) applies. 3

Section 1361(d)(3) provides that the term "QSST" means a trust: (A) the terms of which require that (i) during the life of the current income beneficiary, there shall be only one income beneficiary, (ii) any corpus distributed during the life of the current income beneficiary may be distributed only to such beneficiary, (iii) the income interest of the current income beneficiary in the trust shall terminate on the earlier of such beneficiary's death or the termination of the trust, and (iv) upon the termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to such beneficiary; and (B) all of the income (within the meaning of § 643(b)) of which is distributed (or required to be distributed) currently to one individual who is a citizen or resident of the United States.

Under § 1361(d)(2)(A), a beneficiary of a QSST (or his legal representative) may elect to have § 1361(d) apply. Under § 1361(d)(2)(D), an election under § 1361(d)(2) will be effective up to 15 days and 2 months before the date of the election.

Section 1362(d)(2) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the 1st day of the 1st taxable for which the corporation is an S corporation) such corporation ceases to be a small business corporation.

Section 1.1361-1(j)(6)(iii)(E) of the Income Tax Regulations provides that if a corporation's S election terminates because of a late QSST election, the corporation may request inadvertent termination relief under § 1362(f).

Section 1362(f) provides that if: (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2); (2) the Secretary determines that the circumstances resulting in such termination were inadvertent; (3) no later than a reasonable period of time after discovery of the circumstances resulting in such termination, steps were taken so that the corporation for which the termination occurred is a small business corporation; and (4) the corporation for which the termination occurred, and each person who was a shareholder in such corporation at any time during the period specified pursuant to § 1362(f), agrees to make such adjustments (consistent with the treatment of such corporation as an S corporation, as the case may be) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in such termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely upon the facts presented and the representations made, we conclude that X's S corporation election terminated on Date 4, because D failed to make a timely QSST election under § 1361(d)(2) for Trust 1 and Trust 2. We also conclude that the termination was inadvertent within the meaning of § 1362(f). Therefore, under § 1362(f), X will be treated as an S corporation from Date 4 and thereafter, assuming 4

X's S corporation election is valid and is not otherwise terminated under § 1362(d). However, this ruling is contingent upon D filing a QSST election for Trust 1 and Trust 2, with an effective date of Date 4, with the appropriate service center within 60 days of the date of this ruling. A copy of this letter must 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's original election to be an S corporation was a valid election under § 1362 or whether Trust 1 and Trust 2 are QSSTs within the meaning of § 1361(d)(3).

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

Under the power of attorney on file with this office, we are sending a copy of this letter to X's authorized representative.

Sincerely yours,

Beverly Katz
Senior Technician Reviewer, Branch 2
Associate Chief Counsel
(Passthroughs and Special Industries)

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