Missed elections for three trusts receive S termination relief

Plain-English summary

Shareholders transferred S corporation shares to three trusts whose beneficiaries intended to elect qualified subchapter S trust treatment but did not file the elections on time. The IRS concluded that the missed elections for the first two trusts terminated the corporation’s S election and that the termination was inadvertent. It allowed continued S treatment from the first transfers if all three beneficiaries file their elections within 60 days of the letter. The first two elections must be effective on the earlier transfer date, and the third on its later transfer date, with the ruling attached. The IRS did not independently determine that the corporation otherwise qualifies for S status or that the trusts qualify as QSSTs.

Ruling snapshot

• Question: Can an S corporation obtain relief after transfers to trusts whose beneficiaries missed QSST elections?
• Outcome: Approved: continued S treatment conditioned on all three QSST elections being filed within 60 days with their specified effective dates.
• Key authorities: IRC §§ 1361(c)(2), 1361(d), and 1362(f); IRC §§ 643(b) and 678(a).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200649004
Third Party Communication: None
Release Date: 12/8/2006
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:B01
PLR-110383-06
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Date: July 28, 2006

LEGEND

X = -------------------------------------------
------------------------
State = ---------
Date 1 = --------------------------
Date 2 = ----------------------
Date 3 = --------------------------
Date 4 = --------------------------
Month = --------------
Trust 1 = --------------------------------------------------
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Trust 2 = -----------------------------------------
------------------------
Trust 3 = -----------------------------------------------
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A = ------------------------
B = -----------------------

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

This responds to a letter dated January 30, 2006, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted, X was incorporated on Date 1 under the laws of State. X elected to be treated as an S corporation effective Date 2. Beginning on Date 3, A transferred shares of stock in X to Trust 1 and Trust 2. Beginning on Date 4, B transferred shares of stock in X to Trust 3. In approximately Month, X’s counsel discovered that no QSST elections had been filed for Trust 1, Trust 2, or Trust 3.

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X represents that Trust 1, Trust 2, and Trust 3 were all qualified to elect to be qualified subchapter S trusts (QSSTs), within the meaning of § 1361(d)(3), and that the income beneficiaries of the trusts all intended to file elections to be treated as QSSTs under
§ 1362(d). However, the income beneficiaries of the trusts inadvertently failed to timely file the appropriate elections under § 1362(d)(2). As a result of the failure to file these elections, X’s S corporation election terminated.

X represents that the failure to file the QSST elections for the trusts was not motivated by tax avoidance or retroactive tax planning. X further represents that X and all of its shareholders have consistently treated X as an S corporation at all times since Date 2, and that X’s shareholders (including the trusts) have consistently included their distributive shares of X’s income on their respective federal income tax returns. Finally, X and its shareholders agree to make any adjustments required by the Secretary consistent with 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) defines a “small business corporation” as a domestic corporation that is not an ineligible corporation and that does not (A) have more than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more than one class of stock.

Section 1361(d)(1) provides that a QSST whose beneficiary makes an election under
§ 1362(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the QSST’s beneficiary will be treated as the owner (for purposes of § 678(a)) of that portion of the QSST’s S corporation stock to which the election under § 1362(d)(2) applies. Under
§ 1361(d)(2)(A), a beneficiary of a QSST may elect to have § 1361(d) apply. Under
§ 1361(d)(2)(D), this election will be effective up to 15 days and two months before the date of the election.

Section 1361(d)(3) defines a QSST as 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 of the trust; (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 beneficiary in the trust shall terminate on the earlier of the 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 that beneficiary;

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and (B) all of the income (with 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.

Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) by any corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 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 of the corporation at any time during the period specified pursuant to § 1362(f), agrees to make any adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the circumstances resulting in the termination, the corporation will be treated as continuing to be an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the information submitted and the representations made, we conclude that X’s S election terminated because QSST elections were not filed for Trust 1 or Trust 2. In addition, we conclude that the termination was inadvertent within the meaning of § 1362(f). Therefore, X will be treated as continuing to be an S corporation from Date 3, and thereafter, provided that the beneficiaries for Trust 1, Trust 2, and Trust 3 each file a QSST election with the appropriate service center, effective Date 3 for Trust 1 and Trust 2, and effective Date 4 for Trust 3, within 60 days of the date of this letter. A copy of this letter should be attached to the QSST elections.

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. Specifically, no opinion is expressed concerning whether X is otherwise eligible to be treated as an S corporation, or whether Trust 1, Trust 2, and Trust 3 are eligible to be treated as QSSTs.

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.

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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,

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

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

cc: