PLR 200617012: Missed trust elections treated as an inadvertent S termination

Plain-English summary

A shareholder transferred S corporation stock to two trusts intended to qualify as qualified subchapter S trusts for grandchildren. The trusts' beneficiaries did not timely file the required elections, causing the corporation's S status to terminate when the first trust received stock. The IRS found the termination inadvertent under section 1362(f) and allowed the corporation to continue being treated as an S corporation, assuming its election had otherwise remained valid. The ruling required both trust elections to be filed with the service center within 60 days and required consistent shareholder tax reporting. The IRS did not determine whether the trusts otherwise qualified as qualified subchapter S trusts.

Ruling snapshot

• Question: Could the corporation retain S treatment after its trust shareholders missed their elections?
• Outcome: Approved, conditional on timely remedial trust elections and consistent S corporation reporting.
• Key authorities: IRC §§ 1361(d), 1362(f), 1366-1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200617012
Release Date: 4/28/2006
Index Number: 1361.03-02, 1362.04-00

------------------------------------------------------ Person To Contact:
--------------------------
-----------------------, ID No. 50-09147
--------------------
Telephone Number:
------------------------------------------ --------------------- Refer Reply To:
CC:PSI:2 – PLR-144888-05
-
Date:
December 21, 2005

Legend

X: ------------------------------
---------------------------------------------------

A: ----------------------
---------------------------------------------------

Trust 1: ------------------------------------------------------------
--------------------------------------------------

Trust 2: ------------------------------------------------------------------
--------------------------------------------------

Accounting Firm: -------------------------------------

d1: --------------------------

d2: ----------------------

d3: ----------------------

d4: ----------------------

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

This responds to a letter dated ----------------------, and subsequent correspondence submitted on behalf of X by its authorized representative, requesting inadvertent termination relief under § 1362(f) of the Internal Revenue Code.

2
PLR-144888-05

The information submitted states that X elected to be an S corporation effective d1. A, the majority shareholder of X, created trusts intended to meet the requirements of qualified subchapter S trusts (QSSTs) to facilitate gifts of X stock to two of their grandchildren. On d2, A contributed X stock to Trust 1. On d3, A contributed X stock to Trust 2. However, no QSST election was timely filed on behalf of Trust 1 or Trust 2. Therefore, X's S election terminated on d2. The respective beneficiaries of Trust 1 and Trust 2 reported their allocable share of X's income consistent with the treatment of Trust 1 and Trust 2 as QSSTs. Accounting Firm discovered the failure to timely make the QSST elections after it was hired to provide audit and tax services for X’s tax year ending on d4.

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 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 section 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.

3
PLR-144888-05

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 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 d2, under § 1362(d)(2) , because the of the failure of the beneficiaries of Trust 1 to file a 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 d2 through d3 and thereafter, provided X's S corporation election was valid and was not otherwise terminated under § 1362(d).

X’s shareholders must include their pro rata share of the separately and nonseparately computed items of X as provided in § 1366, make any adjustments to stock basis as provided in § 1367, and take into account any distributions made by X to its shareholders as provided in § 1368.

These rulings are conditioned upon the Trust 1 and Trust 2 filing QSST elections, effective d2 and d3 respectively, with the appropriate Service Center within 60 days of the date of this letter. A copy of this letter should be attached to the QSST elections. If X or X’s shareholders fail to treat X as described above, this ruling will be null and void.

4
PLR-144888-05

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 concerning whether X was or is a small business corporation or whether the Trust 1 and Trust 2 are otherwise eligible to be QSSTs.

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 other authorized representative.

Sincerely,

Bradford R. Poston
Senior Counsel, Branch 2
Associate Chief Counsel
(Passthroughs and Special Industries)

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

cc: