PLR 200716011: Missing trust election was an inadvertent invalid S corporation election

Plain-English summary

A corporation elected S corporation status while a trust held its shares. The trust beneficiary missed the required qualified subchapter S trust (QSST) election because former accountants believed the trust was a grantor trust. The IRS found the resulting invalid S election inadvertent and ruled that the corporation could be treated as an S corporation from the election date until it ceased to exist after a corporate division. Relief required the corporation to file a new Form 2553 and the beneficiary to file a QSST election, both within 60 days and effective as of the original date. The ruling depended on the trust actually qualifying as a QSST, the S election otherwise being valid, and shareholders consistently reporting S corporation tax items.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment despite the missing QSST election?
• Outcome: Approved, subject to corrective filings and stated conditions.
• Key authorities: IRC §§ 1361(d), 1362(f), 1366-1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200716011
Third Party Communication: None
Release Date: 4/20/2007
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-140539-06
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Date:
January 11, 2007

X = -------------------------------------------------------------------------------------------------------
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D1 = -------------------------

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

Trust = -------------------------------------------------------------------------------------------------------
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A = ----------------

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

This responds to a letter dated August 22, 2006, submitted on behalf of X by X’s authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X elected to be an S corporation for its taxable year beginning D1. As of D1, the shareholders of X included individuals and trusts, including Trust. A, the Chairman and CEO of X, represents that Trust has met the qualified subchapter S trust (“QSST”) requirements under § 1361(d)(3) at all times since and including D1. However, the beneficiary of Trust failed to timely make a QSST election because X’s former accountants incorrectly believed that Trust was a grantor trust and thus no election was necessary. Therefore, X’s S election was invalid.

X represents from D1 until D2, X and X’s shareholders have filed tax returns consistent with X being an S corporation. On D2, X ceased to exist following a corporate division.

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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 a "small business corporation" means a domestic corporation that is not an ineligible corporation and that 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 section 1361(b)(1)(B), a trust may be a shareholder if all of it 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. Section 1361(c)(2)(B)(i) provides that for purposes of section 1361(b)(1), in the case of a trust described in section 1361(c)(2)(A)(i), the deemed owner shall be treated as the shareholder.

Section 1361(d)(1) provides that in the case of a QSST with respect to which a beneficiary makes an election under section 1361(d)(2), such trust shall be treated as a trust described in section 1361(c)(2)(A)(i) and, for purposes of section 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 section 1361(d)(2) is made.

Section 1362(d)(2)(A) provides that a beneficiary of a QSST (or his legal representative) may elect to have section 1361(d) apply. Section 1361(d)(2)(D) provides that an election under section 1362(d)(2) shall be effective up to 15 days and 2 months before the date of the election.

Section 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current income beneficiary of the trust must make the QSST election under section 1361(d)(2) by signing and filing with the service center with which the corporation files its income tax return the applicable form or statement including the information listed in section 1.1361-1(j)(6)(ii).

Section 1361(d)(3) provides that the term "qualified subchapter S trust" means a trust- (A) the terms of which require that- (i) during the life of the current income beneficiary, there shall be only 1 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 income beneficiary in the trust shall terminate on the earlier of such beneficiary's death or the termination of the trust, and (iv) upon termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to such beneficiary, and (B) all of the income (within the meaning of section 643(b)) of which is distributed (or required to be distributed) currently to 1 individual who is a citizen or resident of the United States.

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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 1362(a)(2) provides that an election to be an S corporation will only be valid if all persons who are shareholders on the day on which such election is made consent to such election.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was not effective for the taxable year for which it was 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, (2) the Secretary determines that the circumstances resulting in such ineffectiveness were inadvertent, (3) no later than a reasonable period of time after discovery of the event resulting in the ineffectiveness, 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 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 such ineffectiveness, the corporation shall 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 election to be an S corporation on D1 was an inadvertent invalid election within the meaning of § 1362(f).

We further conclude that under § 1362(f), X will be treated as an S corporation from D1 until its termination on D2, provided that Trust qualifies as a QSST, and X's election to be an S corporation was otherwise valid and was not terminated under
§ 1362(d). Accordingly, the shareholders of X must include in income 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 X as described above, this letter ruling will be null and void.

This ruling is conditioned on X, within 60 days of this letter, filing a new Form 2553, Election of a Small Business Corporation with the appropriate service center with an effective date of D1. Furthermore, the beneficiary of Trust must file a QSST election effective D1 with the appropriate service center within 60 days of the date of this letter. A copy of this letter should be attached to the new Form 2553 and the QSST election.

Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the Code,

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including whether X was a small business corporation under § 1361(b), or whether Trust is a QSST within the meaning of § 1361(d)(3).

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

Pursuant to a power of attorney on file with this office, 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