PLR 1042022: IRS grants relief for an inadvertent S election termination involving trusts

Plain-English summary

The IRS considered a corporation's request for relief after its S corporation election terminated when shares were transferred to trusts that did not make timely and valid qualified subchapter S trust elections. The IRS concluded that the termination was inadvertent under IRC § 1362(f), and that the successor trusts would meet the QSST definition under the stated facts. It treated the corporation as an S corporation during the termination period and treated the original and successor trusts as QSSTs for specified periods. The income beneficiary of each successor trust had to file a QSST election effective on the specified date within 120 days after the ruling. The ruling required no adjustments under § 1362(f)(4), but expressed no opinion on other federal tax consequences or on the corporation's eligibility for S status for other reasons.

Ruling snapshot

• Question: Can the corporation receive relief after its S election terminated because trust shareholders did not make valid QSST elections?
• Outcome: Approved
• Key authorities: IRC §§ 1361(a)(1), 1361(b)(1)(B), 1361(d)(3), 1362(d)(2), 1362(f), and 1362(f)(4)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201042022 Third Party Communication: None
Release Date: 10/22/2010 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------------- ----------------------, ID No. -------------
--------------------------- Telephone Number:
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------------------------------------- Refer Reply To:
CC:PSI:B02
PLR-155838-09
Date:
June 25, 2010

X = -----------------------------------------------------------------------------------------------------
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D1 = -----------------

D2 = --------------------------

D3 = ----------------

D4 = --------------------------

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

Trust = -----------------------------------------------------------------------------------------------------
1 ------------------------

Trust = -----------------------------------------------------------------------------------------------------
2 -------------------------

Trust = -----------------------------------------------------------------------------------------------------
3 ------------------------

Trust = -----------------------------------------------------------------------------------------------------
4 -------------------------

Trust = -----------------------------------------------------------------------------------------------------
5 -----------------------

PLR-155838-09 2

Dear --------------

This letter responds to a letter dated December 22, 2009, and subsequent
correspondence, submitted on behalf of X, requesting relief under § 1362(f) of the
Internal Revenue Code.

The information submitted states that X was incorporated in State and elected to be an
S corporation effective D1. Beginning on D2, and subsequent dates, shares of X were
transferred to Trust 1, Trust 2, and Trust 3. Trust 1, Trust 2 and Trust 3 were each
intended to be a qualified subchapter S trust (QSST). However, the income
beneficiaries of each trust failed to file a timely QSST election. Furthermore, Trust 1,
Trust 2, and Trust 3 could not have made valid QSST elections because their terms
failed to require specifically that (1) 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 (2) 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. Consequently,
X’s S election terminated on D2.

On D3, Trust 1 terminated and the shares of X owned by Trust 1 were allocated equally
between Trust 2 and Trust 3. On D4, the trustee of Trust 2 transferred all of the shares
of X owned by Trust 2 to Trust 4 and the trustee of Trust 3 transferred all the shares of
X owned by Trust 3 to Trust 5. X represents that Trust 4 and Trust 5 meet the
requirements to be treated as QSSTs.

X represents that the termination of X’s S election was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. Further, X and X’s shareholders
have continually treated X as an S corporation. As such, all items of income, gain, loss,
and deduction recognized by X since D3 have been allocated among the shareholders
of X, including Trust 1, Trust 2 and Trust 3. In turn, the beneficiaries of each Trust
reported, on their income tax returns for all taxable years since D2, their respective
share of the income, gain, loss and deductions of X. X and its shareholders have
agreed to make such adjustments as the Service may require with respect to all periods
since D2.

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” means a domestic
corporation that is not an ineligible corporation and that 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.

PLR-155838-09 3

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 a
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) is effective
on and after the date of cessation.

Section 1362(f) provides 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 event resulting in the ineffectiveness,
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 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
ineffectiveness, the corporation shall be treated as an S corporation during the period
specified by the Secretary.

Based solely on the information submitted and the representations made, we conclude
that X’s S election was terminated on D2, under § 1362(d)(2), because shares of X
were transferred to an ineligible shareholder, and that this termination of X’s S election
was inadvertent within the meaning of § 1362(f). We further conclude that the terms
that govern Trust 4 and Trust 5 will meet the definition of a QSST under § 1361(d)(3).

Pursuant to the provisions of § 1362(f), X will be treated as an S corporation from D2
and thereafter, provided X’s election to be an S corporation was otherwise valid and
was not terminated under § 1362(d) for other reasons.

During the termination period, Trust 1 will be treated as a QSST described in
§ 1361(d)(3) from D2 to D3. Trust 2 and Trust 3 will each be treated as a QSST from
D2 to D4. In addition, Trust 4 and Trust 5 will each be treated as a QSST (assuming
they otherwise qualify as QSSTs) provided that the respective income beneficiary files a
QSST election effective D4 with the appropriate service center within 120 days following
the date of this letter. Based on the particular facts of this case, no adjustments are
required under § 1362(f)(4).

Except as specifically set forth above, no opinion is expressed concerning the federal
tax consequences of the facts described above under any other provision of the Code.
Specifically, no opinion is expressed on whether X was or is otherwise eligible to be
treated as an S corporation.

PLR-155838-09 4

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.

Pursuant to a power of attorney on file with this office, a copy of this letter is being
forwarded to X’s authorized representatives.

                                    Sincerely,



                                    Bradford R. Poston
                                    Acting Chief, Branch 2
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

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

cc: