PLR 201240014: IRS restores S-corporation status after missed QSST elections

Plain-English summary

A corporation asked the IRS to restore its S-corporation status after shares passed to two trusts and the trusts' beneficiaries did not make the required QSST elections. The IRS concluded that the termination was inadvertent under section 1362(f), so the corporation would be treated as an S corporation from its original election date onward, assuming no other termination applied. The relief was contingent on the two beneficiaries filing QSST elections effective as of the termination date within 120 days of the ruling. The ruling matters because a missed trust election otherwise made the trusts ineligible shareholders and ended the corporation's S election.

Ruling snapshot

• Question: Can an S corporation retain its status after trusts became shareholders without timely QSST elections?
• Outcome: Approved
• Key authorities: IRC §§ 1361 and 1362; IRC §§ 643(b) and 678(a)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201240014
Third Party Communication: None
Release Date: 10/5/2012
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:02
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PLR-117017-12
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Date:
June 08, 2012

LEGEND

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X
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A = ---------------------
B = --------------------------
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C
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D
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Trust 1
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Trust 2
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State = -------------
Date 1 = ------------------
Date 2 = ------------------
Date 3 = ----------------------
Date 4 = ------------------
Date 5 = ------------------------
Date 6 = ------------------------
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Dear ---------------:

This letter responds to a letter dated March 23, 2012 submitted on behalf of X by X’s authorized representative, requesting relief under § 1362(f) of the Internal Revenue Code.

FACTS

A and B, husband and wife, organized X under the laws of State on Date 1. At the time, A and B owned all of the issued and outstanding shares of X. X elected to be treated as an S corporation effective Date 2. B died on Date 3 and A died on Date 4. On Date 5, pursuant to the terms of A’s will, the executors of A’s estate equally divided the residue of A’s estate, which included shares of X, between two separate trusts, Trust 1 and Trust 2, for the respective benefit of A’s two minor grandchildren, C and D. A’s will specifically expressed his intention to preserve X’s S corporation status by organizing and administering Trust 1 and Trust 2 as QSSTs; however, neither C or D nor anyone acting on their behalf made a QSST election. As a result, X’s S corporation status terminated on Date 6.

X represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent and not motivated by tax avoidance. 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. Trust 1, Trust 2, and their beneficiaries have paid income tax in the same amount as if Trust 1 and Trust 2 were electing QSSTs for all relevant years. 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

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) 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 and other than 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 1 class of stock.

Section 1361(d) provides that a QSST whose beneficiary makes an election under § 1362(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the
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QSST’s beneficiary will be treated as the owner (for purposes of § 678(a)) of that portion of the QSST’s S corporation stock to which the election under § 1361(d)(2) applies.

Section 1361(d)(3)(A) provides that for purposes of § 1361(d), the term “qualified subchapter S trust” means a trust, 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 beneficiary may be distributed only to such beneficiary; (iii) the 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 that beneficiary. Section 1361(d)(3)(B) requires the trust to distribute all of its income (within the meaning of § 643(b)) to 1 individual who is a citizen or resident of the United States.

Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) by any corporation (A) was not effective for the taxable year for which it was 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 such ineffectiveness or termination were inadvertent; (3) no later than a reasonable period of time after discovery of the event resulting in the ineffectiveness of 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 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 or 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 the representations made, we conclude that X’s S corporation election terminated on Date 6 because Trust 1 and Trust 2 were not eligible shareholders of X. We further conclude that the termination of X’s S corporation election on Date 6 was inadvertent within the meaning of § 1362(f). Therefore, X, will be treated as an S corporation effective Date 2 and thereafter, provided X’s S corporation election is not otherwise terminated under § 1362(d).

This ruling is contingent upon C and D filing QSST elections for Trust 1 and Trust 2, respectively, with an effective date of Date 6 within 120 days of the date of this ruling. A copy of this letter should be attached to each election.
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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 regarding X’s eligibility to be an S corporation or the validity of its S corporation election. No opinion is expressed as to whether Trust 1 or Trust 2 qualifies as a QSST or whether any other shareholder of X is a permissible S corporation shareholder.

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.

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 Associate Chief Counsel
(Passthroughs & Special Industries)

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

cc: