PLR 1228009: IRS preserves S corporation status after trust election failures

Plain-English summary

An S corporation's two trust shareholders stopped qualifying as qualified subchapter S trusts after failing to distribute all their income, and additional events may have affected one trust's status. The IRS found the resulting S corporation termination and the related trust issues inadvertent. It allowed the corporation to continue as an S corporation from the specified dates, provided one trust filed an ESBT election and the other filed a QSST election using the corrected taxpayer identification numbers within 120 days of the ruling. A copy of the ruling had to accompany both elections.

Ruling snapshot

• Question: Could the corporation retain S corporation status after two trust shareholders failed to satisfy their trust-election requirements?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362(d), and 1362(f); Treas. Reg. §§ 1.1361-1(j)(6) and 1.1361-1(m)(2)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201228009 Third Party Communication: None
Release Date: 7/13/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00 --------------, ID No. -------------
Telephone Number:
---------------------
-------------------------------------- Refer Reply To:
-------------------------------------- CC:PSI:B02
------------------------------- PLR-111350-12
------------------------------- Date:
April 3, 2012

Legend

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

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

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

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

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

Year 1 = -------

Year 2 = -------

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

Tr1EINa = ----------------

Tr1EINb = ----------------

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

Tr2EINa = ----------------

Tr2EINb = ----------------

a = ----------------------------------
----------------------------
PLR-111350-12 2

b = -----------------------------------------
----------------------------

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

This responds to a letter dated March 13, 2012, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting inadvertent
termination relief pursuant to § 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. The parents of a and b
(collectively, the Beneficiaries), acting on behalf of a and b pursuant to § 1.1361-
1(j)(6)(i), made elections to treat Trust 1 and Trust 2 (collectively, the Trusts)
respectively, as qualified subchapter S trusts (QSSTs) effective Date 2. The QSST
elections for Trust 1 and Trust 2 were made using taxpayer identification numbers
Tr1EINa and Tr2EINa, respectively.

On the first day of the year following Year 1, the Trusts ceased to qualify as QSSTs due
to their failure to distribute all of their income (within the meaning of § 1.643(b)-1) to
their respective beneficiaries in Year 1. In addition, in a year following Year 1, Trust 1
made certain payments for the benefit of a that may have satisfied legal support
obligations of a’s parents. Finally, in a year following Year 1, an action taken by a may
have caused Trust 1 to cease to meet the QSST requirements. The failure of the Trusts
to distribute income was discovered in Year 2, as were the other events that may have
caused Trust 1 to cease to meet the QSST requirements. On a date prior to Date 3,
Trust 2 distributed all of its previously undistributed income to b, and since that date has
distributed all of its income currently to b.

X represents that a and b reported their allocable share of Trust 1 and Trust 2’s income,
respectively, on all affected returns consistent with the treatment of the Trusts as
QSSTs. However, for Year 1 and subsequent tax years, Trust 1 and Trust 2 filed
returns using taxpayer identification numbers Tr1EINb and Tr2EINb, respectively. 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 1362(f) provides that if (1) an election under § 1362(a) by any corporation (A)
was not effective for a taxable year for which made (determined without regard to
§ 1362(b)(2)) by reason of a failure to meet the requirements of § 1362(b) or to obtain
shareholder consents, or (B) was terminated under paragraph (2) or (3) of § 1362(d); (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
PLR-111350-12 3

discovery of the event resulting in the effectiveness or 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 § 1362(f), agrees
to making 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 or termination, the
corporation shall 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 the year following Year 1
was inadvertent within the meaning of § 1362(f), as were the post-Year 1 actions of
Trust 1 and a, which may have caused Trust 1 to not qualify as a QSST. 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 through Date 3, and thereafter, provided that X’s S
corporation election was valid, X’s S election was not otherwise terminated under
§ 1362(d) other than as a result of the ownership of its stock by the Trusts, Trust 1 files
an ESBT election effective Date 3 using Tr1EINb, pursuant to the procedures set forth
in § 1.1361-1(m)(2), and Trust 2 files a QSST election effective Date 3 using Tr2EINb,
pursuant to the procedures set forth in § 1.1361-1(j)(6), with the appropriate service
center within 120 days of the date of this letter. A copy of this letter should be attached
to the ESBT election and the QSST election.

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
representative.

                                    Sincerely,




                                    Bradford R. Poston
                                    Senior Counsel, Branch 2
                                    Associate Chief Counsel
                                    (Passthroughs & Special Industries)

Enclosures (4)
3 Copies of this letter
Copy for section 6110 purposes