PLR 200840029: Late QSST election does not end corporation's S status

Plain-English summary

An S corporation shareholder transferred part of the corporation's stock to a trust whose sole current beneficiary was eligible to elect qualified subchapter S trust treatment. The parties intended the trust to be a QSST from the transfer date, but the beneficiary did not timely file the election, technically terminating the corporation's S status. The corporation represented that the failure was inadvertent, was not motivated by tax avoidance or retroactive planning, and would be corrected consistently with continued S treatment. The IRS treated the corporation as continuing its S status from the transfer date. Relief depended on the corporation, trust, and shareholders reporting consistently and on the beneficiary filing the QSST election within 60 days.

Ruling snapshot

• Question: Can the corporation retain S status after a trust shareholder's beneficiary failed to make a timely QSST election?
• Outcome: Approved subject to consistent reporting and filing the QSST election within 60 days.
• Key authorities: IRC §§ 1361(c), 1361(d), 1362(d), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200840029
Third Party Communication: None
Release Date: 10/3/2008
Date of Communication: Not Applicable
Index Number: 1362.04-00; 1361.03-02
Person To Contact:
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Refer Reply To:
CC:PSI:B01
PLR-140959-07
Date: June 23, 2008

Legend:

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

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

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

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

A = -----------------------------------------------------------------------------------------
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B = -----------------------
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Trust = ------------------------------------------------
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Dear ---------------:
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This responds to the letter dated September 11, 2007, and related correspondence, submitted on behalf of X, requesting relief under ' 1362(f) of the Internal Revenue Code (ACode@) for an inadvertent termination of S election.

FACTS

The information submitted states that X was incorporated under the laws of State on D1. X elected to be an S corporation effective D2. On D3, a portion of the X stock held by A, a shareholder of X, was transferred to Trust. B is the sole current beneficiary of Trust.

X and its shareholders represent that Trust was eligible to elect to be a qualified subchapter S trust (QSST) as of D3. X and its shareholders intended that Trust elect to be treated as a QSST, effective D3. The election, however, was not filed timely by B.

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 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) defines an “S corporation” as a small business corporation for which an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a small business corporation cannot 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 a QSST whose beneficiary makes an election under ' 1361(d)(2) will be treated as a trust described in ' 1361(c)(2)(A)(i), thereby, an eligible shareholder of an S corporation, 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.

Section 1361(d)(3) defines the term Aqualified Subchapter S trust@ as 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 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 the termination of the trust during the life of the current beneficiary, the trust shall distribute all its assets to such beneficiary, and; (B) all of the income (within the meaning of
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' 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) shall be terminated whenever (at any time on or after the first day of the taxable year for which the corporation is an S corporation) the corporation ceases to be a small business corporation. The termination is effective on and after the day of cessation. ' 1362(d)(2)(B).

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 consent, or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in the termination, 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 this subsection, 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 termination, such corporation shall 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 election terminated on D3, upon the transfer of X stock to Trust. We also conclude that the termination constituted an Ainadvertent 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 that X=s S election is otherwise valid and has not otherwise terminated under ' 1362(d).

This ruling is contingent upon X and all its shareholders treating X as having been an S corporation and Trust as a QSST for the period beginning D3, and thereafter. Within 60 days from the date of this letter, B, the beneficiary of Trust, must elect to treat Trust as a QSST, effective D3, with the appropriate service center. A copy of this letter should be attached to the election. If these conditions are not met, then this ruling is null and void.
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Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of the above-described facts under any other provision of the Code, including whether X was otherwise eligible to be an S corporation, or whether Trust was otherwise eligible to be a QSST.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code 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 ruling will be sent to your authorized representative.

Sincerely,

Audrey W. Ellis

Audrey W. Ellis
Senior Counsel, Branch 1
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures (2)

Copy of this letter
Copy for ' 6110 purposes