PLR 200804009: Missed trust elections do not defeat intended S status

Plain-English summary

Two trusts owned shares when a corporation attempted to elect S corporation status. Their income beneficiaries did not make timely qualified subchapter S trust, or QSST, elections, so the corporation's S election was ineffective from the start. The IRS found the failure inadvertent and allowed the corporation to be treated as an S corporation from its intended effective date. Each beneficiary had to file a completed QSST election, effective on that date, within 60 days of the letter. Shareholders also had to report income, adjust basis, and account for distributions consistently with S corporation treatment. The IRS did not decide whether the trusts otherwise qualified as QSSTs.

Ruling snapshot

• Question: Could the corporation obtain S status despite two missing QSST elections?
• Outcome: Approved, conditioned on both QSST elections being filed within 60 days and consistent shareholder tax treatment.
• Key authorities: IRC §§ 1361(d), 1362(f), 1366–1368; Treas. Reg. § 1.1361-1(j)(6)(ii).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200804009
Third Party Communication: None
Release Date: 1/25/2008
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-128517-07
Date:

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

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

State =

D1 =

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

This responds to a letter dated June 14, 2007, and subsequent correspondence, submitted on behalf of X by its authorized representative, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

FACTS

The information submitted states that X was incorporated in State on D1. X made an election to be treated as an S corporation effective D1. At that time, Trust 1 and Trust 2 were shareholders of X. A and B were the current income beneficiaries of Trust 1 and
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Trust 2 respectively, but A and B each failed to make timely and effective qualified subchapter S trust (QSST) elections. Therefore, X’s S corporation D1 election was ineffective. X represents that X and each of its shareholders have filed consistent with the treatment of X as an S corporation since D1.

X represents that the failure to properly file the QSST elections for Trust 1 and Trust 2 was not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make any adjustments that the Commissioner may require, consistent with the treatment of X as an S corporation.

LAW AND ANALYSIS

Section 1361(a)(1) of the Code 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(d)(1) provides that in the case of a QSST for which a beneficiary makes an election under § 1361(d)(2), the trust is treated as a trust described in
§ 1361(c)(2)(A)(i), and for purposes of § 678(a), the beneficiary of the trust shall be treated as the owner of that portion of the trust that 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 may elect to have § 1361(d)(1) apply.

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

Section 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the first taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation and (B) any termination under § 1362(d)(2) 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 the ineffectiveness or termination were
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inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in the ineffectiveness or termination, steps were taken (A) so that the corporation is a small business corporation or (B) to acquire the 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 the ineffectiveness or termination, the corporation will be 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 S corporation election on D1 was ineffective and that the ineffectiveness was inadvertent within the meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from D1 and thereafter, provided X’s S corporation election was valid and provided that the election was not otherwise terminated under § 1361(d). Trust 1 and Trust 2 will be treated as QSSTs from D1 until their termination. The shareholders of X must include 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 themselves as described above, this ruling is null and void.

This ruling is conditioned upon A and B each filing an appropriately completed QSST election effective D1 for Trust 1 and Trust 2, respectively. The QSST elections must be filed within 60 days following the date of this letter and a copy of this letter should be attached to the elections.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code. In particular, we express no opinion on whether Trust 1 and Trust 2 were otherwise eligible to be QSSTs.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.
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Pursuant to a power of attorney on file, 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