PLR 200742001: Missed trust income distributions did not permanently end S status

Plain-English summary

Four trusts held shares in an S corporation but did not distribute income each year as required for qualified subchapter S trusts. The omission terminated the corporation's S election, and the trusts later distributed the missed income. The IRS ruled that the termination was inadvertent and that the corporation would continue to be treated as an S corporation from the termination date, provided its original election was valid and it had no other termination. The IRS did not decide whether the corporation otherwise qualified or whether the trusts were eligible qualified subchapter S trusts.

Ruling snapshot

• Question: Could the corporation retain S status after its trust shareholders missed required income distributions?
• Outcome: Yes, subject to the original election being valid and no other termination.
• Key authorities: IRC §§ 1361(d), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200742001
Third Party Communication: None
Release Date: 10/19/2007
Date of Communication: Not Applicable
Index Number: 1362.02-00
Person To Contact:
--------------------------------------------- -------------------------, ID No. -------------
------------------------------------------ Telephone Number:
-------------------------
---------------------
----------------------------------------- Refer Reply To:
CC:PSI:B1
PLR-102696-07
Date: July 9, 2007

LEGEND:

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

Trust 1 = ------------------------------------------------------------
-------------------------------------------

Trust 2 = -------------------------------------------------------------------------------
-------------------------------------------

Trust 3 = --------------------------------------------------------
-------------------------------------------

Trust 4 = ---------------------------------------------------------
------------------------------------------

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

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

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

D4 = ---------------------------

Y1 = -------

Y2 = -------
PLR-102696-07
2

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

This is in reply to a letter dated January 5, 2007, submitted on behalf of X, requesting 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. Trust 1, Trust 2, Trust 3, and Trust 4 (the “Trusts”), shareholders of X, elected to be treated as Qualified Subchapter S Trusts (“QSSTs”) effective D2.

It was intended that the Trusts each qualify as a QSST. However, for taxable years Y1 through Y2, the trustee of the Trusts failed to distribute income annually as required by
§ 1361(d)(3)(B). Therefore, X's election terminated on D3. The Trusts distributed the income for taxable years Y1 through year Y2 on D4.

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.

LAW AND ANALYSIS

Section 1361(a)(1) defines an "S corporation" as a small business corporation for which an election under § 1362(a) is in effect.

Section 1361(b)(1) defines a "small 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
PLR-102696-07
3

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 1361(d)(4)(B) provides that if any QSST ceases to meet any requirement of
§ 1361(d)(3)(B) but continues to meet the requirements of § 1361(d)(3)(A), the provisions of § 1361(d) shall not apply to such trust as of the first day of the first taxable year beginning after the first taxable year for which it failed to meet the requirements of
§ 1361(d)(3)(B).

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 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).

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
PLR-102696-07
4

an S corporation or whether the Trusts are eligible QSSTs 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,

Dianna K. Miosi
Chief, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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