PLR 200925031: Corporation received relief after two QSSTs failed to distribute all income

Plain-English summary

Two trusts holding stock in an S corporation elected qualified subchapter S trust status but failed to distribute all of their income as required. The corporation’s S election therefore terminated. The trustees later distributed the income, and the corporation represented that the failure was inadvertent and not motivated by tax avoidance or retroactive planning. The IRS granted inadvertent-termination relief under section 1362(f), allowing the corporation to be treated as continuously qualifying as an S corporation if its election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Question: Can the corporation retain continuous S status after two shareholder trusts failed to meet the QSST income-distribution requirement?
• Outcome: Approved
• Key authorities: IRC §§ 1361(d) and 1362(d), (f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200925031
Third Party Communication: None
Release Date: 6/19/2009
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.00-00, 1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:B03
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PLR-144264-08
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Date:
March 11, 2009

LEGEND

X = -----------------------------------------------------------------------------------------
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Trust A = -----------------------------------------------------------------------------------------
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Trust B = -----------------------------------------------------------------------------------------
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State = ---------

Year = -------

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

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

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

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

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

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

Date 7 = ---------------------------

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

This letter responds to a letter dated October 13, 2008, and subsequent correspondence, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

X was incorporated under the laws of State in Year. X filed an election to be an S corporation, effective Date 1. On Date 2, Trust A was created under the laws of State. On Date 3, the grantors of Trust A transferred X stock to Trust A. Trust A made an election to be a Qualified Subchapter S Trust (QSST), effective Date 3. On Date 5, Trust B was created under the laws of State and the grantors of Trust B transferred X stock to Trust B. Trust B made an election to be a QSST, effective Date 5.

X intended that both Trust A and Trust B would qualify as a QSST under § 1361(d)(3). X represents that the beneficiaries of Trust A and Trust B have filed income tax returns that are consistent with their status as the sole beneficiaries of a QSST. The trustees of Trust A and Trust B, however, did not distribute all of the income of Trust A or Trust B as required by § 1361(d)(3)(B). Therefore, X’s S election terminated on Date 4. Even if no termination had occurred, X would have ceased being an S corporation as of Date 6.

X represents that the trustees of both Trust A and Trust B took corrective action to distribute all of the income of the trusts by Date 7. Furthermore, 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 tax planning. X and its shareholders consent to make any adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary.

LAW

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) provides that, for purposes of subchapter S, the term “small business corporation” means a domestic corporation which is not an ineligible corporation and 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 1 class of stock.

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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), (A) the trust shall be treated as a trust described in § 1361(c)(2)(A)(i), (B) for purposes of § 678(a), the beneficiary of the 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, and (C) for purposes of applying §§ 465 and 469 to the beneficiary of the trust, the disposition of the S corporation stock by the trust shall be treated as a disposition by the beneficiary.

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 (within 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 1361(d)(4)(B) provides that if any QSST ceases to meet any requirement of § 1361(d)(3)(B) but continues to meet the requirements of § 1361(d)(3)(A), the provisions of § 1361(d) shall not apply to the trust as of the first day of the first taxable year beginning after the first taxable year for which it failed to meet the requirements of § 1361(d)(3)(B).

Section 1362(d)(2) provides that 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. A termination of an S corporation election 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) or § 1361(b)(3)(B)(ii) 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), 1362(d)(3), or 1361(b)(3)(C); (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 such 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 § 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

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in such ineffectiveness or termination, such corporation shall be treated as continuing to be 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 election to be treated as an S corporation terminated on Date 4. We also conclude that the termination was inadvertent 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 Date 4, and thereafter, provided X’s S corporation election was valid and was not otherwise terminated under § 1362(d).

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. In particular, no opinion is expressed as to whether X is otherwise eligible to be an S corporation, or whether the shareholders of X are eligible shareholders, and specifically whether Trust A and Trust B are otherwise eligible to be QSSTs.

This ruling is directed only to the taxpayer requesting 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 is being sent to your authorized representatives.

The ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for a ruling, it is subject to verification on examination.

Sincerely,

/s/

Leslie H. Finlow
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)

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

cc: