PLR 1034016: IRS treats an inadvertently terminated S election as continuing

Plain-English summary

The IRS addressed a corporation whose S corporation election terminated after the current income beneficiary of a trust holding its stock failed to make a qualified subchapter S trust (QSST) election. The corporation represented that the trust had always met the QSST requirements and that the termination was inadvertent and not motivated by tax avoidance or retroactive tax planning. The IRS concluded that the termination was inadvertent and treated the corporation as continuing to be an S corporation from the termination date, assuming its election was otherwise valid and not separately terminated. The trust’s current income beneficiary was required to make a QSST election effective on that date and attach a copy of the ruling.

Ruling snapshot

• Question: May a corporation’s S election continue after it terminates because a trust beneficiary failed to make a QSST election?
• Outcome: Approved
• Key authorities: IRC §§ 1361 and 1362; IRC § 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201034016 Third Party Communication: None
Release Date: 8/27/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00, 1362.02-02, -----------------------, ID No. -------------
Telephone Number:
1362.02-00, 1362.01-03
---------------------
Refer Reply To:
------------------------------------------------ CC:PSI:B01
PLR-155189-09
----------------------------------- Date:
--------------------------------------- May 17, 2010
-----------------------------

Legend:

X = --------------------------------------------

State = -------------

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

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

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

Trust = ------------------------

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

   This responds to a letter dated -------------------------, and subsequent

correspondence, 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,
Trust received stock in X. The current income beneficiary of Trust failed to make an
election to treat the trust as Qualified Subchapter S Trust (QSST). As a result, X’s S
election terminated on Date 3.
PLR-155189-09 2

  X represents that Trust has, at all times met the requirements of a QSST, within

the meaning of § 1361(d)(3).

   X represents that its S corporation election termination was inadvertent and was

not motivated by tax avoidance or retroactive tax planning. 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(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
beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) of that
portion of the QSST which consists of S corporation stock to which an election under
§ 1361(d)(2) applies. Section 1361(d)(2) provides that a beneficiary of a QSST may
elect to have § 1361(d) apply. Under § 1361(d)(2)(D), this election will be effective up to
15 days and 2 months before the date of the election.

    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 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
PLR-155189-09 3

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 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 3 and thereafter, assuming X’s S election is valid and
not otherwise terminated under § 1362(d).

   Within 60 days from the date of this letter, the current income beneficiary of Trust

must elect to treat Trust as a QSST, effective Date 3, with the appropriate service
center. A copy of this letter should be attached to the QSST election.

   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 is 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.
PLR-155189-09 4

  Pursuant to the power of attorney on file with this office, a copy of this letter will

be sent to X’s authorized representative.

                                               Sincerely,

                                                 /s/

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

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

cc: