PLR 200652001: Missed trust election receives inadvertent S termination relief

Plain-English summary

An S corporation's stock passed to a trust after its shareholder died, but the beneficiary did not know a qualified subchapter S trust election was required. The IRS held that the resulting S election termination was inadvertent under section 1362(f). It allowed the corporation to continue as an S corporation and the trust to be treated as a QSST from the stock-transfer date, subject to the stated validity conditions. The beneficiary must file a properly completed QSST election within 60 days of the ruling and attach the letter. The corporation, trust, and beneficiary must report consistently, including income items, basis changes, and distributions, or the ruling becomes void. The IRS did not independently determine whether the trust met the substantive QSST definition.

Ruling snapshot

• Question: Can the corporation preserve S status after the beneficiary missed a required QSST election?
• Outcome: Approved, conditioned on a QSST election within 60 days and consistent reporting.
• Key authorities: IRC §§ 1362(f), 1361(d), 1366, 1367, 1368; Treas. Reg. § 1.1361-1(j)(6)(ii).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200652001
Third Party Communication: None
Release Date: 12/29/2006
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
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CC:PSI:B02
PLR-101743-06
Date:
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September 06, 2006

X = --------------------------------
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A = -----------------
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B = ------------------------

C = --------------------
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Trust = ----------------------------------------
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Date 1= ----------------------

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

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

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

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

This responds to a letter dated December 29, 2005, 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 X elected to be an S corporation effective Date 1. A also represents that B was the sole shareholder of X until B transferred all of B’s shares of stock in X to B’s revocable trust on Date 2.

B died on Date 3. A represents that, upon B’s death, the shares of the stock of X were treated as having been distributed by B’s revocable trust to Trust. Trust was intended to qualify as a Qualified Subchapter S Trust (QSST). However, C the beneficiary of Trust, did not know of the need to file the QSST election required under § 1361(d)(2). Accordingly, no QSST election was filed for Trust until Date 4 when the failure to file the QSST election was discovered and a request that Trust be treated as a QSST effective Date 3 was mailed to the service center. X’s S corporation election terminated on Date 3 when the shares of stock of X were treated as having been distributed to Trust, an ineligible S corporation shareholder.

A represents that the failure to file the QSST election resulting in the termination of X’s S election was not motivated by tax avoidance or retroactive tax planning. X, Trust and C 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) of the Code 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 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.

We conclude that X’s S corporation election terminated on Date 3, the date that Trust, an ineligible S corporation shareholder, was treated as having acquired the stock in X, 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 3 and thereafter, provided X’s S corporation election was valid and provided that the election was not otherwise terminated under § 1361(d). Trust will be treated as a QSST from Date 3, and thereafter. Trust and C must include Trust’s 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, Trust and C fail to treat themselves as described above, this ruling is null and void.

This ruling is conditioned upon the filing of an appropriately completed QSST election effective Date 3, 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 a QSST within the meaning of § 1361(d)(3).

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

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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
(Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes

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