PLR 200704025: Late QSST election can cure inadvertent S corporation termination

Plain-English summary

An S corporation transferred shares to a trust intended to qualify as a qualified subchapter S trust. The beneficiary failed to file the QSST election, causing the corporation's S election to terminate. The IRS found the termination inadvertent and granted section 1362(f) relief, treating the corporation as continuously an S corporation from the transfer date if it otherwise qualified. The trust would likewise be treated as a QSST from that date if it otherwise met the requirements. A completed retroactive QSST election must be filed within 60 days of the letter, and shareholders must report income, basis, and distributions consistently with S treatment.

Ruling snapshot

• Question: Will a missed QSST election permanently terminate the corporation's S status?
• Outcome: Approved, subject to filing the QSST election within 60 days and consistent S reporting.
• Key authorities: IRC §§ 1361(d), 1362(f), and 1366–1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200704025
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:B01
PLR-138983-06
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Date: October 11, 2006

Legend:

X = ---------------------------------------------------
----------------------------------

Trust = ---------------------------------------------------------

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

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

D3 = ----------------------

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

This is in response to a letter dated August 10, 2006, submitted on behalf of X, by its authorized representative, requesting inadvertent termination relief under § 1362(f) of the Internal Revenue Code.

Facts

The information submitted states that X was incorporated on D1 and made an election to be an S corporation effective D2. On D3, shares of X stock were transferred to Trust. It was intended that Trust qualify as a qualified subchapter S trust (QSST). However, the beneficiary of Trust failed to elect to treat Trust as a QSST. Therefore, X’s S election was terminated on D3.

X represents that the circumstances resulting in the termination of X’s S election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its shareholders consent to make any adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary.
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Law and Analysis

Section 1361(a)(1) defines an AS corporation@ as a small business corporation for which an election under ' 1362(a) is in effect.

Section 1361(b)(1) defines a Asmall business corporation@ as a domestic corporation which is not an ineligible corporation which does not (A) have more than 100 shareholders, (B) have as a shareholder a person (other than an estate and other than a trust described in subsection (c)(2)) who is not an individual, (C) have a nonresident alien as a shareholder, and (D) have more than 1 class of stock.

Section 1361(d)(1) provides that a QSST whose beneficiary makes an election under § 1361(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i) and the beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) of that portion of the QSST which consists of S corporation stock to which an election under § 1361(d)(2) applies. Section 1361(d)(2) provides that 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 2 months before the date of the election.

Section 1361(d)(3)(A) 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; and (B) all of the income (within 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(d)(2) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the taxable year for which a corporation is an S corporation) such corporation ceases to be a small business corporation. A termination of an S corporation election under § 1362(d)(2) is effective on and after the date of cessation.

Section 1362(f) provides that if (1) an election under ' 1362(a) by any corporation was terminated under ' 1362(d), (2) the Secretary determines that the circumstances resulting in the termination were inadvertent, (3) no later than a reasonable period of time after the discovery of the circumstances resulting in the termination, steps were taken so that the corporation is a small business corporation, and (4) the corporation, and each person who was a shareholder of the corporation at any time during the period of inadvertent termination of the S election, agrees to make
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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 termination, the corporation is treated as an S corporation during the period specified by the Secretary.

Conclusion

Based solely on the facts submitted and the representations made, we conclude that X’s election to be treated as an S corporation terminated on D3. We also conclude that the termination was an inadvertent termination within the meaning of ' 1362(f). Accordingly, under the provisions of ' 1362(f), X will be treated as continuing to be an S corporation from D3, and thereafter, provided that X=s S corporation election was valid and was not otherwise terminated under ' 1362(d). X’s shareholders, in determining their respective income tax liabilities during the termination period and thereafter, must include their pro rata share of the separately stated computed items of income or loss of X, as provided in § 1366, make any adjustments to basis provided in § 1367, and take into account any distributions made by X as provided in § 1368.

Additionally, from D3 and thereafter, Trust will be treated as a QSST described in § 1361(d)(3) (assuming that it otherwise qualifies as a QSST). This ruling is conditioned upon the filing of a completed QSST election for Trust effective D3 with the appropriate service center within 60 days of the date of this letter.

Except as specifically provide herein, no opinion is expressed or implied as to the federal tax consequences of the facts described above under any other provision of the Code. In particular, no opinion is expressed as to whether X is otherwise eligible to be an S corporation or whether Trust is an eligible QSST under ' 1361(d).

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

Under a power of attorney on file in this office, a copy of this letter will be sent to X’s authorized representative.

Sincerely,

Audrey W. Ellis
Senior Counsel, Branch 1
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

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