PLR 1330012 provides relief for an inadvertent S corporation termination

Plain-English summary

The IRS provides relief for an inadvertent termination of an S corporation election caused by trust shareholders that were not treated as qualified subchapter S trusts. One trust did not make the required QSST election when it acquired the corporation's stock, and another ceased to qualify after its income beneficiary died and the shares were not distributed within the permitted period. The corporation may continue to be treated as an S corporation if it files the first trust's QSST election within 120 days, the second trust distributes all shares to eligible shareholders, and the S election is not otherwise terminated. The ruling does not decide whether the corporation or either trust was otherwise eligible for the relevant status.

Ruling snapshot

• Question: May the corporation retain S corporation treatment after the described trust-shareholder failures?
• Outcome: Approved, relief granted under IRC § 1362(f), subject to stated conditions.
• Key authorities: IRC §§ 1361(d), 1362(d)(2), and 1362(f); Treas. Reg. § 1.1361-1(j).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201330012 Third Party Communication: None
Release Date: 7/26/2013 Date of Communication: Not Applicable
Index Number: 1361.03-02, 1362.04-00
Person To Contact:
----------------------------------------------- -----------------------, ID No. --------------
------------------------------------ Telephone Number:
----------------- ----------------------
----------------------------------- Refer Reply To:
CC:PSI:B01
PLR-142930-12
Date:
March 15, 2013

Legend

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

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

     State             =        ---------

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

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

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

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

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

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

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

  This responds to the letter dated September 17, 2012, submitted on behalf of X,

requesting relief under § 1362(f) of the Internal Revenue Code (“Code”) for an
inadvertent termination of X's S election.
PLR-142930-12 2

                                      Facts

  The information submitted states that X was incorporated under the laws of State

and elected to be an S corporation effective Date 1.

Trust 1

   On Date 2, Trust 1 acquired X stock. On Date 2, Trust 1 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 Trust 1 as a QSST. Therefore, Trust 1 was not
an eligible shareholder, and X’s S corporation election was terminated.

   X represents that the circumstances resulting in the termination 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 for X and a valid
QSST election for Trust 1. 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.

Trust 2

  Trust 2, whose sole income beneficiary was A, filed a QSST election effective

Date 1. Trust 2 owned X stock.

   On Date 3, A died. Trust 2 continued to qualify as a permissible S corporation

shareholder under § 1361(c)(2)(A)(ii) for the 2-year period beginning on Date 3 and
ending on Date 4. Under the terms of Trust 2, the X shares were to be divided amongst
A’s heirs. However, the shares were not distributed. Therefore, Trust 2 ceased to be
an eligible S corporation shareholder on Date 4, and X’s S corporation election would
have terminated on Date 4 if it had not already terminated on Date 2.

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

corporation election were inadvertent and not motivated by tax avoidance. Upon
discovery, X and Trust 2 have taken remedial measures; the shares of X held by Trust 2
have been distributed to individual shareholders. 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.

                                Law and Analysis

PLR-142930-12 3

    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)(B) provides that a “small business corporation” means a

domestic corporation that is not an ineligible corporation and that 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(c)(2)(A)(i) provides that for purposes of § 1361(b)(1)(B), a trust

may be a shareholder if all of it is treated (under subpart E of part I of subchapter J of
chapter 1) as owned by an individual who is a citizen or resident of the United States.

   Section 1361(c)(2)(A)(ii) provides that a trust which was described in

§ 1361(c)(2)(A)(i) immediately before the death of the deemed owner and which
continues in existence after such death, but only for the 2-year period beginning on the
day of the deemed owner's death, may be an S corporation shareholder.

    Section 1361(c)(2)(B)(i) provides that for purposes of § 1361(b)(1), in the case of

a trust described in § 1361(c)(2)(A)(i), the deemed owner shall be treated as the
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), such trust shall be treated as a trust
described in § 1361(c)(2)(A)(i) and, 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 the trust must make the QSST election under § 1361(d)(2) by
signing and filing with the service center with which the corporation files its income tax
return the applicable form or 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 1361(d)(3) provides that the term “qualified subchapter S trust” means a

trust- (A) the terms of which require that- (i) during the life of the current income
PLR-142930-12 4

beneficiary, there shall be only 1 income beneficiary of the trust, (ii) any corpus
distributed during the life of the current income beneficiary may be distributed only to
such beneficiary, (iii) the income 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 termination of the trust during the life of the current income beneficiary,
the trust shall distribute all of its assets to such beneficiary, and (B) all of the income
(within the meaning of § 643(b)) of which is distributed (or required to be distributed)
currently to 1 individual who is a citizen or resident of the United States.

  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 termination.

   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 § 1362(d)(2);
(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 so that the corporation for which the election was made or the termination
occurred is a small business corporation, or 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.

                                    Conclusion

    Based solely on the information submitted and the representations made, we

conclude that X’s S corporation election was terminated as of Date 2 because X had an
ineligible shareholder. We further conclude that the termination of X’s S election on
Date 2 was inadvertent within the meaning of § 1362(f). Pursuant to the provisions of
§ 1362(f), X will be treated as continuing to be an S corporation as of Date 2 and
thereafter, provided that (1) X files a QSST election for Trust 1 effective Date 2 with the
appropriate service center within 120 days from the date of this letter; (2) Trust 2
distributes all shares of X held by Trust 2 to eligible shareholders; and (3) X's S
corporation election is not otherwise terminated under § 1362(d). A copy of this letter
must be attached to the QSST election.
PLR-142930-12 5

     Except as specifically ruled upon above, we express or imply no opinion

concerning the federal tax consequences of the facts of this case under any other
provision of the Code. Specifically, we express or imply no opinion regarding X’s
eligibility to be an S corporation or whether Trust 1 and Trust 2 were otherwise eligible
to be QSSTs.

  This ruling is directed only to the taxpayer who requested it. According to

§ 6110(k)(3), this ruling may not be used or cited as precedent.

   In accordance with a power of attorney on file with this office, a copy of this letter

is being sent to X’s authorized representative.

                                   Sincerely,


                                   Joy Spies
                                   Joy Spies
                                   Senior Technician Reviewer, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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

cc: