PLR 1036005: S corporation election restored after missed QSST election

Plain-English summary

The IRS ruled that a corporation's S corporation election terminated when stock was transferred to a qualified subchapter S trust and the trust's income beneficiary failed to file the required QSST election. The IRS found that the termination was inadvertent because the corporation and its shareholders had intended to continue S corporation treatment and had reported consistently with that treatment. Under section 1362(f), the corporation could be treated as continuing to be an S corporation from the termination date if the beneficiary filed a QSST election effective on that date within 120 days of the ruling. During the termination period and afterward, the trust would be treated as a QSST and the beneficiary as the owner of the corporation stock held by the trust. The shareholders also had to make the required pass-through, basis, and distribution adjustments, and the ruling would become void if the parties failed to follow those conditions.

Ruling snapshot

• Question: May an S corporation election be restored after a QSST beneficiary inadvertently failed to file the required election?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368; Treas. Reg. § 1.1361-1(j)(6)(ii)

Full text (IRS public release)

• Internal Revenue Service Department of the Treasury
  Washington, DC 20224

Number: 201036005 Third Party Communication: None
Release Date: 9/10/2010 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00 -------------------, ID No. ------------
Telephone Number:
--------------------
------------------------------------------------- Refer Reply To:
----------------------------------- CC:PSI:3
--------------------------------- PLR-110581-10
--------------------------- Date:
June 08, 2010

                                                    LEGEND

Company = ------------------------------------------------

Date1 = ------------------------

Date2 = ----------------

Date3 = ----------------------

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

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

A = -------------------

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

     This letter responds to a letter dated March 2, 2010, and subsequent

correspondence, submitted on behalf of Company, requesting a ruling under § 1362(f)
of the Internal Revenue Code.

                                                    FACTS

    The information submitted states that Company is a State corporation that

elected to be an S corporation effective Date1. On Date2, stock in Company was
PLR-110581-10 2

transferred to Trust. At all times prior to and after the stock transfer, Trust met the
definition of a “qualified subchapter S trust” (QSST) under § 1361(d)(3). However, due
to inadvertence, A, the income beneficiary of Trust, failed to file an election with the
service center under § 1361(d)(2) to treat Trust as an eligible S corporation shareholder
under § 1361(c)(2)(A)(i). Consequently, Company’s S corporation election terminated
on Date2.

   On Date3, Company learned that its S corporation election had terminated on

Date2. Since Date2, Company has treated Trust as a QSST under § 1361(d) and A has
reported A’s allocable share of Company’s income consistent with the treatment of Trust
as a QSST.

   Company represents that there was no intent to terminate Company’s S

corporation election and that the termination was inadvertent and not motivated by tax
avoidance or retroactive tax planning. Company and its shareholders have treated
Company as an S corporation since Date1. In addition, Company and its shareholders
agree to make any adjustments consistent with the treatment of Company 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) defines a “small business corporation” as a domestic

corporation which is not an ineligible corporation and which 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
one class of stock.

   Section 1361(c)(2)(A)(i) provides that for purposes of § 1361(b)(1)(B), a trust all

of which is treated (under subpart E of part I of subchapter J of chapter 1 of the Internal
Revenue Code) as owned by an individual who is a citizen or resident of the United
States may be a shareholder.

    Section 1361(d)(1)(A) provides that in the case of a QSST with respect to which

a beneficiary makes an election under 1361(d)(2)--(A) the trust is treated as a trust
described in § 1361(c)(2)(A)(i), and (B) for purposes of § 678(a), the beneficiary of the
trust is 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.
PLR-110581-10 3

  Section 1361(d)(2)(A) provides that a beneficiary of a QSST (or his legal

representative) may elect to have § 1361(d) apply.

    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 statement including the information listed in § 1.1361-1(j)(6)(ii).

   Section 1362(a) provides that, except as provided in § 1362(g), a small business

corporation may elect to be an S corporation.

   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 first taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation.

    Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any

corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that
the circumstances resulting in such termination were inadvertent; (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation; and (4) the corporation for which the termination
occurred, and each person who was a shareholder of the corporation at any time during
the period specified pursuant to § 1362(f), agrees to make the 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 the termination, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

                                  CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

Company’s S corporation election terminated on Date2 when stock in Company was
transferred to Trust, and Trust failed to make a QSST election. We also conclude that
the termination of Company's S corporation election was inadvertent within the meaning
of § 1362(f).

   Accordingly, under § 1362(f), Company will be treated as continuing to be an S

corporation from Date2 and thereafter, provided that Company’s S corporation election
was valid and was not otherwise terminated under § 1362(d), and provided that A files a
QSST election for Trust with an effective date of Date2 with the appropriate service
center within 120 days from the date of this letter. A copy of this letter should be
attached to the QSST election.
PLR-110581-10 4

   During the termination period and thereafter, Trust will be treated as a QSST

described in § 1361(d) (assuming the trust otherwise qualifies as a QSST), and A will be
treated as the owner of Company stock held by Trust. Accordingly, all of Company’s
shareholders in determining their respective income tax liabilities during the termination
period and thereafter, must include their pro rata share of the separately stated items of
income (including tax-exempt income), loss, deduction, or credit and non-separately
computed items of income or loss of Company under § 1366, make any adjustments to
basis under § 1367, and take into account any distributions made by Company under
§ 1368. If Trust, Company, or Company’s shareholders fail to treat Company as
described above, this ruling shall be null and void.

   Except as specifically set forth above, we express or imply no opinion concerning

the federal tax consequences of the facts described above under any other provision of
the Code. Specifically, we express no opinion on whether Company is otherwise eligible
to be an S corporation or whether Trust qualifies as a QSST.

  This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)

provides that it may not be used or cited as precedent.

    Pursuant to a power of attorney on file with this office, we are sending a copy of

this letter to Company's authorized representative.

                                  Sincerely,

                                  /s/

                                  James A. Quinn
                                  Senior Counsel, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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