PLR 200637003: Corporation retains S status after trust shareholder error

Plain-English summary

Shares of an S corporation were transferred to a trust that had not made the required qualified subchapter S trust (QSST) election. The IRS found that the transfer terminated the corporation's S election but that the termination was inadvertent. It treated the corporation as continuing to be an S corporation if the QSST election was filed within 60 days with an effective date matching the transfer, the trust otherwise qualified, and the corporation's S election was otherwise valid. The ruling gives conditional relief from the loss of S status caused by the trust shareholder.

Ruling snapshot

• Question: Can the corporation retain S status after a trust acquired shares without a timely QSST election?
• Outcome: Approved, subject to a timely corrective QSST election and the stated qualification conditions.
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii).

Full text (IRS public release)

Number: 200637003
Release Date: 9/15/2006
Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Third Party Communication: None
Index Number: 1362.02-00
Date of Communication: Not Applicable

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Person To Contact:
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Refer Reply To:
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CC:PSI:1
PLR-100886-06
Date: June 5, 2006
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Legend

X = -----------------------------------
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State = -------------

D1 = -----------------------

D2 = -----------------------

Trust = --------------------------------------------------------------
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a = --------

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

This responds to a letter dated December 28, 2005, submitted on behalf of X, requesting relied under section 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted, X was formed under the laws of State on D1. X elected to be treated as an S corporation for federal tax purposes, effective D1.

On D2, a shares of X stock were transferred to Trust. Trust intended to meet the requirements of a Qualified Subchapter S Trust (QSST). However, a timely QSST election was not filed on behalf of Trust. Upon a review of Trust’s documents, Trustee’s
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tax advisor discovered that Trust was an ineligible shareholder. Accordingly, Trust was amended on D3. X represents that Trust meets the requirements of a QSST.

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. LAW AND ANALYSIS

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 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
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business corporation. Section 1362(d)(2)(B) provides that the termination shall be effective on and after the date of cessation.

Section 1362(f), in relevant part, 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 (B) was terminated under ' 1362(d)(2); (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 so that the corporation is once more a small business corporation; and (4) the corporation, and each person who was a shareholder in the corporation at any time during the period specified pursuant to this subsection, 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 shall be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

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). Further, we conclude that this termination of X's S corporation 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 and thereafter, provided that the required QSST election with an effective date of D2 is filed with the appropriate service center within 60 days from the date of this letter, Trust otherwise qualifies as a QSST, and X's S corporation election was valid and was not otherwise terminated under § 1362(d).

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

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

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,
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David R. Haglund
Senior Technician Reviewer, Branch 1
Office of Associate Chief Counsel
(Passthroughs & Special Industries)

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