PLR 1238008: IRS restores S corporation and QSub status after an inadvertent trust-related termination

Plain-English summary

An S corporation's sole shareholder transferred the corporation's voting stock to a grantor trust and later died. The corporation's S election terminated when the trustees did not make an election for the trust to be an electing small business trust. The IRS ruled that the termination of the corporation's S election and its subsidiary's QSub election was inadvertent, and allowed both elections to be treated as effective from the specified date, subject to the statutory rules. The trust could be treated as an ESBT if it otherwise qualified and the trustees filed the required election and amended returns within 120 days. The ruling illustrates the relief available under § 1362(f) when an S corporation corrects an inadvertent eligibility failure.

Ruling snapshot

• Question: Can an S corporation and its QSub retain their tax status after the shareholder's death when the trust holding the stock did not timely elect ESBT status?
• Outcome: Approved, subject to filing and tax-payment conditions.
• Key authorities: IRC §§ 671, 1361, 1362, and 170.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201238008 Third Party Communication: None
Release Date: 9/21/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00, 1362.01-03 ----------------------, ID No. -----------------
Telephone Number:
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-------------------------------------- Refer Reply To:
------------------------------------- CC:PSI:02
----------------------------------- PLR-105731-12
------------------------------- Date:
June 04, 2012

                                                   LEGEND

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

X =
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Y =
----------------------------

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

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

Trust =
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State = -------------

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

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

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

Date 4 = -------------------

Date 5 = -----------------

Date 6 = -----------------

PLR-105731-12 2

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

    This letter responds to a letter dated February 1, 2012 and subsequent

correspondence submitted on behalf of X by X’s authorized representative, requesting
relief 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’s subsidiary, Y, is also incorporated under the laws of State. X timely
elected to be treated as an S corporation effective Date 2 and elected to treat Y as a
qualified subchapter S subsidiary (QSub) effective Date 2.

    A, the sole shareholder of X at that time, created Trust on Date 3. On Date 4, A

transferred all of the voting stock in X to Trust. Trust was a grantor trust wholly owned
by A under § 671. A died on Date 5. X’s S corporation status terminated on Date 6
when the trustees failed to make an election to treat Trust as an electing small business
trust (ESBT).

   X represents that the circumstances resulting in the termination of X’s S

corporation election were inadvertent. X further represents that X and its shareholders
have filed their federal income tax returns consistent with having a valid S corporation
election in effect for all taxable years since X elected to be an S corporation. X and its
shareholders consent to making any adjustments (consistent with the treatment of X as
an S corporation) as may be required by the Secretary.

                                LAW & ANALYSIS

   Section 1361(a)(1) of the Code 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)(B) provides that the term “small business corporation” means a

domestic corporation which is not an ineligible corporation and which 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.

  Section 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as

provided in § 1362(e)(1)(B), an ESBT means any trust if (i) such trust does not have as a
beneficiary any person other than (I) an individual, (II) an estate, (III) an organization
described in § 170(c)(2), (3), (4), or (5), or (IV) an organization described in § 170(c)(1)
which holds a contingent interest in such trust and is not a potential current beneficiary,
(ii) no interest in such trust was acquired by purchase, and (iii) an election under § 1361(e)
applies to such trust.

   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 relevant part, that if (1) an election under § 1362(a)

or § 1361(b)(3)(B)(ii) by any corporation 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 was terminated under §§ 1362(d)(2), (3), or 1362(b)(3)(C);
(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 such ineffectiveness, steps were taken so
that the corporation is a small business corporation or a qualified subchapter S
subsidiary; and (4) the corporation and each person who was a shareholder in 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 or a qualified subchapter S subsidiary) 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 or a
qualified subchapter S subsidiary during the period specified by the Secretary.

                                  CONCLUSION

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

that X’s S corporation election and Y’s QSub election terminated on Date 6 and that
these terminations were inadvertent within the meaning of § 1362(f). We further
conclude that, pursuant to the provisions of § 1362(f), X will be treated as an S
corporation and Y will be treated as a QSub effective Date 2 and thereafter, provided
that such elections are not otherwise terminated under § 1362(d). Trust will be
treated as an ESBT from Date 6, provided that Trust is otherwise eligible to be an ESBT.

    This ruling is contingent upon the trustees of Trust filing a properly completed

ESBT election effective Date 6 with the appropriate service center within 120 days
following the date of this letter and upon Trust filing any necessary amended returns
and paying any additional tax and interest due within 120 days following the date of
this letter. A copy of this letter should be attached to the ESBT election and any relevant
amended return.

  The rulings contained in this letter are based upon information and

representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

    Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed or implied concerning
whether X otherwise qualifies as an S corporation, whether Y otherwise qualifies as a
QSub, whether Trust otherwise qualifies as a QSST, or whether any other shareholder
of X is a permissible S corporation shareholder.

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

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

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

                                    Sincerely,



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

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

cc: