PLR 200746002: S corporation status continues if two beneficiaries file late trust elections

Plain-English summary

A corporation's S election terminated when its shares were transferred to two trusts and their beneficiaries failed to make qualified subchapter S trust (QSST) elections. The corporation said the failure was inadvertent and that it and its shareholders had continued filing as if S status remained in effect. The IRS granted inadvertent termination relief under § 1362(f), treating S status as continuing from the stock transfer date. Each beneficiary had to file a QSST election effective from that date within 60 days of the ruling, and shareholders had to report income, basis, and distributions consistently with S corporation treatment. The IRS did not separately determine whether the trusts actually qualified as QSSTs.

Ruling snapshot

• Question: Could the corporation retain S status after two trust beneficiaries missed QSST elections?
• Outcome: Inadvertent termination relief granted, subject to two timely filed QSST elections and consistent tax 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: 200746002
Third Party Communication: None
Release Date: 11/16/2007
Date of Communication: Not Applicable

Person To Contact:
Index Number: 1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:B02
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PLR-108063-07
Date:
August 09, 2007

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

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

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

Trust1 = -----------------------------------------------------------------------------------------------------
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Trust2 -----------------------------------------------------------------------------------------------------
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Dear --------------:

This responds to a letter dated February 12, 2007, and subsequent correspondence 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 was incorporated D1 and elected to be an S corporation effective D2. On D3, shares of X were transferred to Trust1 and Trust2. Trust1 and Trust2 were intended to meet the requirements of a qualified

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subchapter S trust (QSST). X represents that Trust1 and Trust2 have met the QSST requirements under § 1361(d)(3) at all times since and including D3. However, the beneficiaries of Trust1 and Trust2 inadvertently failed to timely make QSST elections. Therefore, X’s S election terminated on D3.

X represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent and not motivated by tax avoidance. X further represents that from D3, X and its shareholders have filed all returns consistent with X’s status as an S corporation. 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 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 § 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 § 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), such trust shall be treated as a trust described in § 1361(c)(2)(A)(i) and, 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 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 § 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 § 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

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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 § 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.

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 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, or (B) was terminated under § 1362(d)(2) or (3), (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 S corporation election terminated on D3, under § 1362(d)(2), because of the failure of the Trust1 beneficiary and the Trust2 beneficiary to make the 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 D3 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 must include pro rata their share of separately stated items of income (including tax-exempt income), loss, deduction, or credit, and nonseparately stated 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.

This ruling is contingent upon the Trust1 beneficiary and the Trust2 beneficiary filing QSST elections for Trust1 and Trust2, respectively, with an effective date of D3, with the appropriate service center within 60 days of the date of this ruling. A copy of

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this letter should be attached to each of the QSST elections. If X or its shareholders fail to treat X as described above, this letter ruling will be null and void.

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, including whether X was a small business corporation under § 1361(b), or whether Trust1 and Trust2 are QSSTs 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,

Bradford R. Poston
Senior Counsel, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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

cc: