PLR 200906037: A missed QSST election received inadvertent-termination relief

Plain-English summary

An S corporation's stock passed to a trust under a deceased shareholder's will. The trust was a permitted shareholder for two years but did not make a timely qualified subchapter S trust election, causing the corporation's S status to terminate. A second trust that later received stock made its QSST election on time, and both trusts continuously met the substantive QSST requirements. The IRS ruled that the termination was inadvertent and that the corporation would continue to be treated as an S corporation from a specified date. Relief required the corporation and all shareholders to use consistent treatment and required the first trust's beneficiary to file a retroactive QSST election within 60 days. The IRS did not otherwise rule on the corporation's S status or either trust's QSST qualification.

Ruling snapshot

• Question: Could the corporation preserve S status after the first trust failed to file a timely QSST election?
• Outcome: Approved: the termination was inadvertent, subject to consistent treatment and a QSST election filed within 60 days.
• Key authorities: IRC §§ 1361(b), 1361(c), 1361(d), 1362(d), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200906037
Third Party Communication: None
Release Date: 2/6/2009
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00, 1361.03-02
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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-141575-08
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Date:
October 30, 2008

Legend:

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

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

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

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

Date 4 = -------------------

Date 5 = ---------------------

Date 6 = -------------------------

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

This responds to a letter dated August 28, 2008, 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 2. On Date 3, stock in X was transferred to Trust 1 pursuant to the terms of the will of a deceased shareholder. Trust 1 qualified as a permissible S corporation shareholder under § 1361(c)(2)(A)(iii) for the two-year period beginning on Date 3. Trust 1 did not file a timely Qualified Sub-Chapter S Trust (QSST) election resulting in the termination of X’s S corporation status.

On Date 4, stock in X was transferred to Trust 2 pursuant to the terms of the will of a deceased shareholder. Trust 2 qualified as permissible S corporation shareholder under § 1361(c)(2)(A)(iii) for the two-year period beginning on Date 4. On or about Date 5, Trust 2 made a timely QSST election pursuant to § 1361(d)(2).

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). X 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) 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(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)(ii) provides, that for purposes of § 1361(b)(1)(B), a trust which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed
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owner and which continues in existence after such death, may be an S corporation shareholder, but only for the two year period beginning on the day of the deemed owner’s death.

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 “qualified 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 § 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 -
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(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 the termination of X’s S election constituted an “inadvertent termination” within the meaning of § 1362(f).

Further, we conclude that, pursuant to § 1362(f), X will be treated as continuing to be an S corporation from Date 6 and thereafter, assuming X’s S election is valid and not otherwise terminated under § 1362(d). Accordingly, X will be treated as an S corporation at the time of Trust 2’s timely QSST election.

This ruling is contingent upon X and all its shareholders treating X as having been an S corporation and Trust 1 as a QSST for the period beginning Date 6, and thereafter. Within 60 days from the date of this letter, the beneficiary of Trust 1 must elect to treat Trust 1 as a QSST, effective Date 6, 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.

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 a valid S corporation, or whether Trust 1 or Trust 2 was otherwise a valid QSST.

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.

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,

David R. Haglund

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