PLR 200946008: An S corporation's invalid election was cured after a missed QSST election

Plain-English summary

The IRS ruled that an S corporation's election was ineffective because a trust shareholder's QSST election was not timely filed, but that the invalidity was inadvertent. The corporation would be treated as continuing as an S corporation if the beneficiary filed the QSST election with the required effective date within 60 days. The ruling was based on representations that the corporation and shareholders had reported consistently and had not intended to make an invalid election. It did not decide the corporation's or trust's underlying eligibility.

Ruling snapshot

• Question: Could an S corporation continue after a trust shareholder missed its QSST election?
• Outcome: Approved
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. § 1.1361-1(j)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200946008
Third Party Communication: None
Release Date: 11/13/2009
Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-106959-09
Date: August 11, 2009

LEGEND

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

Date = ------------------
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Date = ----------------------
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Date = ------------------
3
Date = -----------------
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Dear -----------------:

This letter responds to a letter dated February 16, 2009, and subsequent correspondence, submitted on behalf of X by X’s authorized representatives, requesting inadvertent invalid S corporation relief pursuant to § 1362(f) of the Internal Revenue Code (Code). In addition, X’s representatives also seek relief to allow Trust to file a late election to be treated as a qualified subchapter S trust (QSST) pursuant to § 1361(d) of the Code.
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FACTS

X was incorporated under the laws of State on Date 1, and elected to be treated as an S corporation, effective Date 3. As of Date 3, the shareholders of X included individuals and trusts, including Trust. Pursuant to a Trust Reformation effective Date 2, Trust became a qualified subchapter S trust (QSST) within the meaning of § 1361(d)(3), and has been since and including Date 2, and was therefore eligible to be an S corporation shareholder. A was the sole beneficiary of Trust, and inadvertently failed to file a timely QSST election. Therefore, X’s S election was invalid.

X became aware of Trust’s failure to file the QSST election on Date 4. X represents that since Date 3, all of its shareholders have filed their income taxes as if X was an S corporation. X and its shareholders represent there was no intent to knowingly make an invalid election to be an S corporation, and that the events that resulted in the inadvertent invalid election were not motivated by tax avoidance or retroactive tax planning. X and all of its shareholders who were shareholders since Date 3 agree to make any adjustments consistent with the treatment of X as an S corporation as may be required by the Secretary.

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)(B) provides that, for purposes of subchapter S, 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(c)(2)(A)(i) provides that, for the purposes of § 1362(b)(1)(B), a trust all of which is treated (under subpart E of part I of subchapter J of this chapter) as owned by an individual who is a citizen or resident of the United States, may be an S corporation shareholder.

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) such trust will be treated as a trust described in § 1361(c)(2)(A)(i), and (B) for purposes of § 678(a), the beneficiary of such 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 such beneficiary.
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Section 1361(d)(2)(A) provides that a beneficiary of a QSST (or his legal representative) may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that an election under § 1361(d)(2) shall be effective up to 15 days and 2 months before the date of the election.

Section 1361(d)(3) provides the term “qualified subchapter S trust” means 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 income beneficiary, the trust shall distribute all of 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. A substantially separate and independent share of a trust within the meaning of § 663(c) shall be treated as a separate trust for purposes of § 1361(d) and § 1361(c).

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

Section 1.1361-1(j)(6)(iii)(B) provides that if a trust holds C corporation stock and that C corporation makes an S election effective for the first day of the taxable year in which the S election is made, the QSST election must be made within the 16-day-and- 2-month period beginning on the day that the S election is effective.

Section 1.1361-1(j)(7)(i) provides that the income beneficiary who makes the QSST election and is treated (for purposes of § 678(a)) as the owner of that portion of the trust that consists of S corporation stock is treated as the shareholder for purposes of §§ 1361(b)(1), 1366, 1367, and 1368.

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation 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 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
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discovery of the circumstances resulting in such ineffectiveness or termination, steps were taken so that the corporation for which the election was made or the termination occurred is a small business corporation, or to acquire the required shareholder consents, and (4) the corporation for which the election was made or the termination occurred, and each person who was a shareholder in such corporation at any time during the period specified pursuant to 1362(f), agrees to make such adjustments (consistent with the treatment of such corporation as an S corporation) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in such ineffectiveness or termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the representations made and the information submitted, we conclude that X’s S election was ineffective on Date 3 because of the failure of A to make a QSST election. We further conclude that the ineffectiveness of X’s S corporation election constituted an inadvertent invalid election 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 3 and thereafter provided that X’s S election was otherwise valid and not otherwise terminated under § 1362(d).

This ruling is contingent upon A filing a QSST election for Trust, with an effective date of Date 3, with the appropriate service center within 60 days of the date of this letter. A copy of this letter should be attached to the QSST election.

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 or implied concerning whether X is otherwise eligible to be treated as an S corporation or whether Trust is eligible to be a QSST under § 1361(d)(3).

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 a power of attorney on file with this office, we are sending a copy of this letter to your authorized representatives.
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The rulings contained in this letter are 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 rulings, it is subject to verification on examination.

Sincerely,

/s/

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

Enclosures (2):

A copy of this letter
A copy for § 6110 purposes