PLR 200718011: Late trust elections treated as inadvertent S termination

Plain-English summary

An S corporation shareholder died and left shares to three testamentary trusts, each with the same beneficiary. The beneficiary failed to file timely qualified subchapter S trust elections, so the corporation’s S status ended when the trusts’ two-year eligibility period expired. The IRS found the termination inadvertent and ruled that the corporation could continue to be treated as an S corporation. The relief required consistent shareholder reporting and QSST elections effective from the termination date within 60 days. The IRS did not determine whether the trusts otherwise qualified as QSSTs.

Ruling snapshot

• Question: Could the corporation retain S status after its trust beneficiary missed the QSST election deadline?
• Outcome: Approved, conditioned on timely QSST elections and consistent S corporation tax treatment.
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(f), 1366-1368.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200718011
Release Date: 5/4/2007
Index Number: 1362.04-00
Person To Contact:
--------------------, ID No. -------------
---------------------------------------
Telephone Number:
--------------------------------
---------------------
-----------------------------
Refer Reply To:
----------------------------
------------------------------
CC:PSI:B3
PLR-135678-06
Date: January 18, 2007

-

Legend

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

A = ----------------------

B = ----------------------

Trusts = --------------------------------------
---------------------------------------------------

--------------------------------------------------------
---------------------------------------------------

-----------------------------------------------------
---------------------------------------------------

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

Date 1 = ---------------------

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

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

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

PLR-135678-06
2

Date 5 = ------------------------

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

This responds to a letter dated July 18, 2006, submitted on behalf of X from X’s authorized representative, requesting inadvertent termination relief pursuant to § 1362(f) of the Internal Revenue Code.

Facts

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 2. A, was a shareholder of X. On Date 3, A died. Pursuant to the terms of A’s Will, shares of X stock were transferred to three testamentary trusts (the Trusts) on Date 4.

Under the terms of each of the Trusts, the sole beneficiary of each of the Trusts was B. X represents that each of the Trusts was intended to qualify as a qualified subchapter S trust (QSST) under § 1361(d). However, B did not file timely QSST elections on behalf of the Trusts. Therefore, X's S corporation election terminated two years after Date 4, on Date 5. B reported B's allocable share of the Trusts' income consistent with the treatment of the Trusts as QSSTs on all affected returns.

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.

Law and Analysis

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) 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, in part, 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.

PLR-135678-06
3

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(c)(2)(A)(iii) provides 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 two-year period beginning on the day on which the stock is transferred to it.

Section 1361(c)(2)(B)(i) provides that, for purposes of § 1361(b)(1), in the case of a trust described in § 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 § 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.

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 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).

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 was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in such termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in such termination, steps were taken so that the corporation for which the termination occurred is a small business corporation, 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

PLR-135678-06
4

such period, then, notwithstanding the circumstances resulting in such termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

Conclusion

Based solely on the representations made and the information submitted, we conclude that X's S corporation election terminated under § 1362(d)(2) on Date 5, when the Trusts became ineligible shareholders. We also conclude that this termination was inadvertent 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 5 and thereafter, provided that 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, make any adjustments to basis as provided in § 1367, and take into account any distributions made by X as provided in § 1368.

Additionally, during the termination period and thereafter, the Trusts will be treated as QSSTs described in § 1361(d)(3) (assuming the trusts otherwise qualify as QSSTs), and B will be treated as the owner of the X stock held by the Trusts, provided that B files QSST elections effective Date 5 with the appropriate service center within 60 days following the date of this letter. If the Trusts, 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 Trusts are eligible to be QSSTs under § 1361(d)(3).

This ruling letter 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.

PLR-135678-06
5

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

Sincerely,

/s/

Mary Beth Collins
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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