PLR 1242009: IRS grants relief for an inadvertent S corporation election failure

Plain-English summary

The IRS granted relief to a corporation whose S corporation election was ineffective because a trust that acquired its stock did not make the required qualified subchapter S trust election. The IRS found that the failure was inadvertent and agreed to treat the corporation as an S corporation from the redacted effective date. The relief was conditioned on the trust beneficiary filing an effective QSST election within 120 days of the ruling date and on the corporation and its shareholders making any required adjustments. The ruling did not express an opinion on the corporation's general eligibility to be an S corporation or on the trust's eligibility to be a QSST.

Ruling snapshot

• Question: Could the corporation receive relief under IRC § 1362(f) after its S corporation election became ineffective because a trust did not make a QSST election?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1361(d)(1) and (d)(2), 1362(a), 1362(d)(2), and 1362(f); Treas. Reg. §§ 1.1361-1(j)(6) and (j)(7); IRC § 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201242009 Third Party Communication: None
Release Date: 10/19/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.00-00, 1362.04-00 ----------------------, ID No. -----------------
Telephone Number:
--------------------
------------------------- Refer Reply To:
------------- CC:PSI:2
------------------------------- PLR-119929-12
------------------------- Date:
-------------------------- June 19, 2012

Legend

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

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

State = ------

D1 = -------------------

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

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

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

This responds to a letter dated March 30, 2012, submitted on behalf of X by X’s
authorized representative, requesting relief under § 1362(f) of the Internal Revenue
Code (the Code).

According to the information submitted and the representations made, X was
incorporated on D1, under the laws of State. On D2, the Trust acquired X stock. X filed
a timely election under § 1362(a) to be treated as an S corporation effective D3. On D3,
the Trust was eligible to file an election pursuant to § 1361(d)(2) to be treated as a
qualified subchapter S trust (QSST). However, no election was made to treat the Trust
as a QSST. Therefore, the Trust was not an eligible shareholder and X’s S corporation
election was ineffective.

X represents that the circumstances resulting in the ineffectiveness of X’s S election
were inadvertent and were not motivated by tax avoidance or retroactive tax planning.
Additionally, X represents that X and its shareholders have filed their federal income tax
returns consistent with having made a valid S corporation election in effect for X. X and
its shareholders have agreed to make such adjustments (consistent with the treatment
of X as an S corporation) as may be required by the Secretary. X represents that the
sole income beneficiary of the Trust has reported all the income of the Trust on the
beneficiary’s Form 1040, U.S. Individual Income Tax Return since D3.

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) 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, 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(c)(2)(A)(i) provides that, for purposes of § 1362(b)(1)(B), a trust, all of
which is treated (under title 26, subtitle A, chapter 1, subchapter J, part I, subpart E of
the United States Code) as owned by an individual who is a citizen or resident of the
United States, may be an S corporation 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 will 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 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current
income beneficiary of a QSST must make the election under § 1361(d)(2) by signing
and filing with the service center with which the corporation files its income tax returns
the applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

Section 1.1361-1(j)(6)(iii) provides that, if S corporation stock is transferred to a trust,
the QSST election must be made within the 16-day-and-2-month period beginning on
the day the stock is transferred to the trust. If a C corporation has made an election
under § 1362(a) to be an S corporation (S election) and, before that corporation’s S
election is in effect, stock of that corporation is transferred to a trust, the QSST election
must be made within the 16-day-and-2-month period beginning on the day that the
stock is transferred to the trust.

Section 1.1361-1(j)(7)(i) provides that the income beneficiary who makes the QSST
election and is treated (for purposes of § 678(a)) as the owner of that portion of the trust
that consists of S corporation stock is treated as the shareholder for purposes of
§§ 1361(b)(1), 1366, 1367, and 1368.

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 the
corporation is an S corporation) such corporation ceases to be a small business
corporation. The termination is effective on and after the day of the cessation. Section
1362(d)(2)(B).

Section 1362(f) provides, in part, 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 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 discovery of the circumstances resulting in such ineffectiveness or
termination, steps were taken (A) so that the corporation for which the election was
made or the termination occurred is a small business corporation, or (B) to acquire the
required shareholder consents; and (4) the corporation for which the election was made
or the termination occurred, and each person who was a shareholder in such
corporation at any time during the period specified pursuant to § 1362(f), agrees to
make such adjustments (consistent with the treatment of such 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, such
corporation shall be treated as an S corporation during the period specified by the
Secretary.

Based on the information submitted and the representations made, we conclude that
X’s D3 S corporation election was ineffective because X had an ineligible shareholder.
We further conclude that the ineffectiveness of X’s S corporation election was
inadvertent within the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), X
will be treated as an S corporation from D3 and thereafter, provided that X’s election to
be an S corporation was not otherwise ineffective and was not terminated under §
1362(d), so long as the beneficiary of the Trust files an effective QSST election effective
D3, 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 QSST election.

Except for the specific ruling above, no opinion is expressed or implied concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, no opinion is expressed or implied regarding X’s eligibility to be an S
corporation or the Trust’s eligibility to be a QSST.

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 X’s authorized
representative.

                                  Sincerely,



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

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

cc: