PLR 200705012: Missed elections for separate trust shares receive S termination relief

Plain-English summary

S corporation shares were transferred to a trust that divided into separate shares for two beneficiaries. Both beneficiaries missed the qualified subchapter S trust (QSST) elections, terminating the corporation's S election. The IRS granted inadvertent termination relief under section 1362(f), preserving S treatment from the transfer date if no other defect existed. Each beneficiary must file a QSST election effective on that date within 60 days of the ruling. The shareholders must report their shares of corporate items, adjust basis, and account for distributions consistently with S treatment; failure to follow the required treatment makes the ruling void. The IRS did not independently determine whether the trust shares qualified as QSSTs or the corporation otherwise qualified for S status.

Ruling snapshot

• Question: Can missed QSST elections for two separate trust shares be corrected while preserving S status?
• Outcome: Approved, subject to elections within 60 days and consistent tax reporting.
• Key authorities: IRC §§ 1361(d), 1362(f), 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: 200705012
Release Date: 2/2/2007
Index Number: 1362.04-00

• Person To Contact:
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  ------------------------------------ Telephone Number:
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  Refer Reply To:
  CC:PSI:2 – PLR-130307-06
  Date:
  October 18, 2006

Legend:

X = ---------------------------------------------------
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A = -------------------------------
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B = ------------------------
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Trust = -----------------------------------------------------------------------------------------
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Date 1 = ----------------------

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

State = ----------------

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

This responds to a letter dated April 17, 2006, submitted on behalf of X by its
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authorized representative, requesting relief pursuant to § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated under the laws of State on Date 1 and elected to be treated as an S corporation, effective Date 1. On Date 2, shares of X were transferred to Trust, for the benefit of A and B. Trust’s terms provide that Trust will be divided into separate shares in the event that Trust owns stock in an S corporation. The separate shares of Trust were each intended to meet the requirements of a qualified subchapter S trust (QSST). However, neither income beneficiary filed a timely QSST election for their separate share of Trust. Therefore, X's S election terminated on Date 2. X and all its shareholders filed tax returns in a manner consistent with X being an S corporation and the separate shares of Trust being QSSTs.

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

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.
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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 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 business corporation. Section 1362(d)(2)(B) provides that the termination 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 such ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness or termination, steps were taken -- (A) so that the corporation is a small business corporation, or (B) to acquire the required shareholder consents, and (4) the corporation, and each person who was a shareholder in 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 such ineffectiveness or termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

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).

Based solely on the representations made and the information submitted, we conclude that X's S corporation election terminated on Date 2, under § 1362(d)(2), because of the failure of the beneficiaries of the separate shares of Trust to file QSST elections, and that this termination of X's S 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 Date 2 and thereafter, provided X's S corporation election was valid and was not otherwise terminated under § 1362(d). All of 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 items of income (including tax-exempt income), loss, deduction, or credit and non-separately stated computed items of income or loss of X as provided in § 1366,
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make any adjustments to basis provided in § 1367, and take into account any distributions made by X as provided in § 1368.

Additionally, during the termination period and thereafter, the separate shares of Trust will be treated as QSSTs described in § 1361(d)(3) (assuming they otherwise qualify as QSSTs), and A and B will be treated as the owner of the X stock held by each separate share of Trust, provided that A and B each file a QSST election effective Date 2 with the appropriate service center within 60 days following the date of this letter. If Trust, X, or X's shareholders fail to treat X as described above, this ruling shall be null and void. A copy of this letter should be attached to the QSST elections.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provision of the Code. Specifically, no opinion is expressed on whether X is otherwise eligible to be treated as an S corporation or whether the separate shares of Trust is eligible to be a QSST under § 1361(d)(3).

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

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

Sincerely,

Bradford R. Poston
Senior Counsel, Branch 2
Associate Chief Counsel
(Passthroughs and Special Industries)

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