PLR 1047018: An inadvertent QSST failure did not terminate the corporation's S election

Plain-English summary

The IRS considered an S corporation whose shareholder trust stopped qualifying as a Qualified Subchapter S Trust because it failed to distribute all of its income to the beneficiary. The trust later made a corrective distribution, and the corporation represented that the failure was inadvertent, not tax-motivated, and corrected within a reasonable period. The IRS ruled that the termination of the corporation's S election was inadvertent under IRC § 1362(f) and that the corporation would continue to be treated as an S corporation, assuming the election was valid and was not otherwise terminated. The ruling did not address other federal tax consequences.

Ruling snapshot

• Question: Could the corporation retain its S status after its shareholder trust inadvertently failed to qualify as a QSST?
• Outcome: approved
• Key authorities: IRC §§ 1361, 1362, 643, and 678.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201047018 Third Party Communication: None
Release Date: 11/26/2010 Date of Communication: Not Applicable
Index Number: 1362.04-00, 671.02-00
Person To Contact:
--------------------------------------------- ------------------, ID No. -------------
------------------------------- Telephone Number:
-------------------- ---------------------
----------------------------------------------- Refer Reply To:
CC:PSI:B02
PLR-126772-10
Date:
July 23, 2010

LEGEND

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

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

              --------------------------------

a = ------------------------

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

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

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

Year 1 = -------

Year 2 = --------

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

This responds to a letter dated June 24, 2010, submitted on behalf of X, requesting a
ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated in State on Date 1. X made
an election to be treated as an S corporation effective Date 2. Trust made an election
to be treated as a Qualified Subchapter S Trust (QSST) with respect to a effective Date
2.

PLR-126772-10 2

On the first day of the year following Year 1, Trust ceased to qualify as a QSST due to
its failure to distribute all of its income (within the meaning of § 1.643(b)-1) to a in Year

1. Trust discovered the failure in Year 2 and made a corrective distribution to a
   representing all undistributed income between Year 1 and Year 2.

X represents that a reported a’s allocable share of Trust’s income on all affected returns
consistent with the treatment of the Trust as QSST. X further represents that X filed as
an S corporation for all years from and after Date 2. 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.

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) as owned by an
individual who is a citizen or resident of the United States may be a 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 shall 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.

Section 1361(d)(3) provides that, for purposes of § 1361(d), a QSST 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.

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 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) or (3), (2) the Secretary
determines that the circumstances resulting in the ineffectiveness or termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in the ineffectiveness or termination, steps were taken (A) so
that the corporation is a small business corporation or (B) to acquire the 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

PLR-126772-10 3

corporation) as may be required by the Secretary with respect to such period, then,
notwithstanding the circumstances resulting in the ineffectiveness or termination, the
corporation will be treated as an S corporation during the period specified by the
Secretary.

Based solely on the facts submitted and the representations made, we conclude that
the termination of X’s S corporation election on the first day of year following Year 1 was
inadvertent within the meaning of § 1362(f). We further hold that, pursuant to the
provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date
2 and thereafter, provided X’s S corporation election was valid and provided that the
election was not otherwise terminated under § 1361(d).

Except as specifically ruled above, we express no opinion concerning the federal tax
consequences of the transactions described above under any other provisions of the
Code.

This ruling is directed only to the taxpayer that requested it. Section 6110(j)(3) provides
that it may not be used or cited as precedent.

Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s
authorized representative.

                                   Sincerely,




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

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