PLR 201325006: IRS grants relief for an inadvertent S corporation election failure

Plain-English summary

An S corporation owned two subsidiaries and had elected to treat them as qualified subchapter S subsidiaries. The corporation later discovered that the trust holding its stock had not made the required qualified subchapter S trust election, and the wrong person had signed the S corporation consent. The IRS concluded that the S corporation and QSub elections were ineffective but that the failure was inadvertent. It granted relief under section 1362(f), treating the corporation as an S corporation and the subsidiaries as QSubs from the original effective date, subject to timely corrective filings. The ruling did not decide whether the entities otherwise qualified.

Ruling snapshot

• Question: Could the corporation receive relief for inadvertent failures affecting its S corporation and QSub elections?
• Outcome: Approved
• Key authorities: IRC §§ 1361(d), 1361(b)(3), and 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201325006
Third Party Communication: None
Release Date: 6/21/2013
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Refer Reply To:
CC:PSI:03
PLR-141361-12

March 18, 2013

LEGEND

X = -----------------------------------------------------------------------------------------------------------------
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Sub1 = -----------------------------------------------------------------------------------------------------------------
--------

Sub2 = -----------------------------------------------------------------------------------------------------------------

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

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

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

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

State = -------

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

This letter responds to a letter dated September 19, 2012, and subsequent correspondence, submitted on behalf of X by its authorized representative requesting a ruling under § 1362(f) of the Internal Revenue Code (“Code”).
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FACTS

X was incorporated under the laws of State on D1 and elected to be an S corporation effective D2. X wholly owns two State corporations, Sub1 and Sub2. X made an election to treat Sub1 and Sub2 as qualified subchapter S subsidiaries (“QSubs”) effective D2. On D2, Trust owned shares of X stock. X represents that Trust satisfies the qualified subchapter S trust (“QSST”) requirements under § 1361(d)(3). However, X recently discovered in D3 that the income beneficiary of Trust failed to file an election to be a QSST effective D2. Additionally, the trustee of Trust, not the beneficiary of Trust, signed the consent for Form 2553, Election by a Small Business Corporation. Therefore, Trust was not a permitted shareholder and X’s S corporation election was ineffective. Because X’s S corporation election was ineffective, X’s elections to treat Sub1 and Sub2 as QSubs were also ineffective.

X represents that the ineffective elections were not motivated by tax avoidance or retroactive tax planning. X further represents that X and its shareholders have filed consistently with the treatment of X as an S corporation since D2. X and its shareholders have agreed to make any adjustments that the Commissioner may require, consistent with the treatment of X as an S corporation and Sub1 and Sub2 as QSubs.

LAW AND ANALYSIS

Section 1362(a) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1361(a)(1) 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) provides that the term “small business corporation” means 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 one class of stock.

Section 1361(b)(3)(A) provides that, except as provided in regulations prescribed by the Secretary, for purposes of the Code — (i) a corporation which is a QSub shall not be treated as a separate corporation, and (ii) all assets, liabilities, and items of income, deduction, and credit of a QSub shall be treated as assets, liabilities, and such items (as the case may be) of the S corporation.
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Section 1361(b)(3)(B) provides that the term “QSub” means any domestic corporation which is not an ineligible corporation (as defined in § 1361(b)(2)), if (i) 100 percent of the stock of such corporation is held by the S corporation, and (ii) the S corporation elects to treat such corporation as a QSub.

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 1 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 a QSST whose beneficiary makes an election under § 1361(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) 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)(2)(A) provides that a beneficiary of a QSST (or his legal representative) may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that an election under § 1361(d)(2) shall be effective up to 15 days and 2 months before the date of the election.

Section 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current income beneficiary of the trust must make the election under § 1361(d)(2) by signing and filing with the service center where the corporation files its income tax return the applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

Section 1362(d)(2)(A) provides that an election under § 1362(a) will 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 that if (1) an election under §§ 1362(a) or 1361(b)(3)(B)(ii) 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) or § 1361(b)(3)(C), (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 a QSub, as the case may be, 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 corporation or a QSub, as the case may be) as may be required by the Secretary with
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respect to such period, then, notwithstanding the circumstances resulting in the ineffectiveness or termination, the corporation will be treated as an S corporation or a QSub, as the case may be, 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 X’s elections to treat Sub1 and Sub2 as QSubs were ineffective for the taxable year beginning D2. We also conclude that the circumstances resulting in such ineffectiveness were inadvertent within the meaning of § 1362(f). Accordingly, under § 1362(f), X will be treated as an S corporation from D2 and thereafter, provided X’s S corporation election was otherwise valid and has not otherwise terminated under § 1361(d), and Sub1 and Sub2 will be treated as QSubs from D2 and thereafter, provided that Sub1’s and Sub2’s QSub elections were otherwise valid and have not otherwise terminated under § 1361(b)(3)(C).

This ruling is conditioned on the beneficiary of Trust filing a QSST election for Trust, effective D2, 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.

Furthermore, as a condition to this ruling, a consent to X’s S corporation election, signed by Trust's beneficiary, must be filed with the appropriate service center, indicating that the consent is to be associated with the originally filed Form 2553, within 120 days of this letter. A copy of this letter should be attached to the consent.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the facts described above under any other provisions of the Code. Specifically, we express no opinion regarding X’s eligibility to be an S corporation, Sub1’s and Sub2’s eligibility to be QSubs, or Trust’s eligibility to be a QSST.
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This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with a power of attorney on file with this office, we are sending a copy of this letter to X’s authorized representative.

Sincerely,

Mary Beth Carchia
Acting Branch Chief, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes