PLR 200704022: Two testamentary trusts receive conditional late QSST election relief

Plain-English summary

An estate transferred an S corporation's shares to two trusts with the same current income beneficiary. The beneficiary missed both qualified subchapter S trust elections, and the corporation's S election terminated. The IRS found the termination inadvertent under section 1362(f) and treated the corporation as continuing its S status from the termination date. Both trusts would be treated as QSSTs from that date until their termination. Relief requires retroactive QSST elections and any necessary amended returns from the trusts, beneficiary, and affected shareholders within 60 days. Consistent reporting of income, basis, and distributions is required, and the IRS reserved whether the trusts otherwise meet QSST requirements.

Ruling snapshot

• Question: Can missed QSST elections for two inherited-stock trusts be cured without losing S status?
• Outcome: Approved, conditioned on both elections, necessary amended returns within 60 days, and consistent reporting.
• Key authorities: IRC §§ 1361(d), 1362(f), and 1366–1368; Treas. Reg. § 1.1361-1(j)(6)(ii).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200704022
Third Party Communication: None
Release Date: 1/26/2007
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:
CC:PSI:B02
PLR-138645-06
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Date:
October 16, 2006

X = ------------------------------------------------------------------------------------------------------
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A = ------------------------------------------------------------------------------------------------------
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B = ------------------------------------------------------------------------------------------------------
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Trust = ------------------------------------------------------------------------------------------------------
1
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= ------------------------------------------------------------------------------------------------------ Trust ------------------------
2
State = ------------------

D1 = -------------------
D2 = ----------------
D3 = ------------------------------------------------------------------------------------------------------ D4 = ------------------------------------------------------------------------------------------------------ D5 = ----------------------

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

This responds to a letter dated August 4, 2006, and subsequent correspondence, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated in State on D1. X made an election to be treated as an S corporation effective D2. At that time X was
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owned by A and B. B died on D3. By operation of B’s last will and testament, B’s estate transferred its shares to Trust 1 and Trust 2 on D4. A was the current income beneficiary of both trusts, but A failed to make timely qualified subchapter S trust (QSST) elections for either trust. X’s S corporation election terminated on D5. X represents that X, Trust 1, Trust 2, and A have consistently reported as if valid QSST elections had been filed for each trust.

X represents that the failure to file the QSST elections for Trust 1 and Trust 2 was not motivated by tax avoidance or retroactive tax planning. 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.

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.

Prior to the Small Business Job Protection Act of 1996, Section 1361(c)(2)(A)(iii) provided that for purposes of § 1361(b)(1)(B), a trust with respect to stock transferred to it pursuant to the terms of a will may be a shareholder, but only for the 60 day period beginning on the day on which suck stock is transferred to it. The Small Business Job Protection Act of 1996 changed the 60 day period to a 2 year period, effective for tax years beginning after December 31, 1996.

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 § 1361(d)(1) apply.

Section 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current income beneficiary of a QSST must make the election under § 1361(d)(2) by signing 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).
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Section 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the first taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation and (B) any termination under § 1362(d)(2) 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 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.

Based solely on the facts submitted and the representations made, we conclude that X’s S corporation election terminated on D5 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 D5 and thereafter, provided X’s S corporation election was valid and provided that the election was not otherwise terminated under § 1361(d). Trust 1 and Trust 2 will be treated as QSSTs from D5 until their termination. The shareholders of X must include their 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 or its shareholders fail to treat themselves as described above, this ruling is null and void.

This ruling is conditioned upon (1) the beneficiary of Trust 1 and Trust 2 filing appropriately completed QSST elections effective D5; and (2) Trust 1, Trust 2, the beneficiary of the trusts, and any other affected shareholders of X filing any amended returns necessary to conform to this letter. The QSST elections and any amended returns must be filed within 60 days following the date of this letter and a copy of this letter should be attached to any such elections or returns.
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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 1 or Trust 2 is otherwise eligible to be a QSST.

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.

Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s authorized representative.

Sincerely,

Beverly Katz
Senior Technician Reviewer, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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