IRS preserves S corporation status after trust beneficiaries miss QSST elections

Plain-English summary

Shares of an S corporation passed under a will to two trusts, which were permitted shareholders for two years. After that period, the trusts became ineligible because their beneficiary had not filed qualified subchapter S trust elections. The IRS found the resulting termination of the company's S election inadvertent and agreed to treat the company as continuously an S corporation. The relief required the beneficiary to file both QSST elections within 60 days, effective when the trusts became ineligible, and required consistent tax treatment by the company and its shareholders. The IRS did not independently decide whether the company or trusts otherwise met the eligibility rules.

Ruling snapshot

• Question: Could the company retain S corporation status after missed QSST elections made two shareholder trusts ineligible?
• Outcome: Approved, conditional on timely QSST filings and consistent treatment.
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d)(2), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200833002
Third Party Communication: None
Release Date: 8/15/2008
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:B01
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PLR-100700-08
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Date:
May 15, 2008

LEGEND

X = --------------------------
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State = --------

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

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

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

Trust 1 = ---------------------------------------------------------
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Trust 2 = -----------------------------------------------
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Dear ------------:

This responds to a letter dated November 2, 2007, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted, X was incorporated on Date 1 under the laws of State. X elected to be treated as an S corporation effective Date 1. On Date 2, stock in X was transferred to Trust 1 and Trust 2 pursuant to the terms of the will of a deceased
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shareholder. Trust 1 and Trust 2 qualified as permissible S corporation shareholders under § 1361(c)(2)(A)(iii) for the two-year period beginning on the Date 2.

On Date 3, Trust1 and Trust 2 became ineligible shareholders of X. As a result, X’s election to be an S corporation terminated. X represents that Trust 1 and Trust 2 have, at all times since the transfer of X stock to Trust 1 and Trust 2, met the requirements of qualified subchapter S trusts (QSSTs), within the meaning of § 1361(d)(3). However, the beneficiary of Trust 1 and Trust 2 failed to timely file an election under § 1361(d)(2) for Trust 1 and Trust 2 to be QSSTs. X represents that X, Trust 1, and Trust 2 were unaware of the need to file a QSST election in order for Trust 1 and Trust 2 to continue to qualify as eligible S corporation shareholders beginning on Date 3. X further represents that it did not intend for its S corporation election to terminate and the termination was not motivated by tax avoidance. Finally, X and its shareholders agree to make any adjustments required by the Secretary consistent with the treatment of X as an S corporation.

LAW AND ANALYSIS

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) defines a “small business corporation” as a domestic corporation that is not an ineligible corporation and that does not (A) have more than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more than one class of stock.

Section 1361(c)(2)(A)(i) provides that 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 an S corporation 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 is a permitted shareholder, but only for the 2-year period beginning on the day on which such stock is transferred to it.

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 QSST’s beneficiary will be treated as the owner (for purposes of § 678(a)) of that portion of the QSST’s S corporation stock to which the election under § 1362(d)(2) applies.
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Section 1361(d)(3) 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 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 (with 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 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever the corporation ceases to be a small business corporation.

Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) by any corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 termination, steps were taken so that the corporation is once more a small business corporation, 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 any adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the circumstances resulting in the termination, the corporation will be treated as continuing to be an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the information submitted and the representations made, we conclude that X’s S election terminated on Date 3 when Trust 1 and Trust 2 became ineligible S corporation shareholders, and that the termination was inadvertent within the meaning of § 1362(f). Therefore, X will be treated as continuing to be an S corporation from Date 3, and thereafter, provided that X’s S corporation election was otherwise valid and was not otherwise terminated under § 1362(d).

This ruling is contingent upon X and all of its shareholders treating X as having been an S corporation, and treating Trust 1 and Trust 2 as having been QSSTs, for the period beginning Date 3, and thereafter. Within 60 days from the date of this letter, the beneficiary of Trust 1 and Trust 2 must file elections to treat Trust 1 and Trust 2 as QSSTs, effective Date 3, with the appropriate service center. A copy of this letter should be attached to the elections. If these conditions are not met, then this ruling is null and void.
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Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, no opinion is expressed concerning whether X is otherwise eligible to be treated as an S corporation, or whether Trust 1 or Trust 2 is eligible to be treated as a QSST.

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

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

/s/

David R. Haglund
Senior Technician Reviewer, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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

cc: