PLR 201333002: IRS grants inadvertent termination relief for an S corporation with QSST shareholders

Plain-English summary

An S corporation's election terminated because three trusts that held its shares did not distribute all of their income to their beneficiaries while the beneficiaries were under age 21. The corporation represented that the trusts were intended to qualify as qualified subchapter S trusts and that the failure was inadvertent. The IRS granted relief under IRC § 1362(f), treating the corporation as continuing to be an S corporation and the trusts as QSSTs from the termination date, subject to the stated conditions. The corporation and its shareholders must make the required pass-through and basis adjustments.

Ruling snapshot

• Question: May the corporation receive relief after its S election terminated because its trust shareholders failed to satisfy the QSST distribution requirement?
• Outcome: Approved. The corporation's S status and the trusts' QSST treatment continue from the termination date, subject to the ruling's conditions.
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368; Treas. Reg. § 1.1361-1(j).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201333002
Third Party Communication: None
Release Date: 8/16/2013
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------
---------------------, ID No. ------------------
------------------------------------
Telephone Number:
---------------------------
----------------------
---------------------------------
Refer Reply To:
CC:PSI:B01
PLR-104519-13
Date:
April 19, 2013

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

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

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

Trust 3 = -----------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-
----------------------------------------------------------------
-------------------------------------------------------------------
----------------------------------------------------

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

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

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

Date 4 = ----------------------
PLR-104519-13
2

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

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

Date 7 = ----------------------

p = -----

q = -----

r = -----

s = --------------------------------------------------

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

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

This responds to a letter dated January 15, 2013, and subsequent correspondence, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

X was incorporated on Date 1, and made an election to be treated as an S corporation effective Date 2. On Date 3, Trust 1, Trust 2, and Trust 3 held p, q, and r shares, respectively, of X stock.

In Year 1, the beneficiaries of Trust 1, Trust 2, and Trust 3 each made an election to have the trust be a qualified subchapter S trust (“QSST”). It is represented that the three trusts possessed the elements of a QSST described in § 1361(d)(3)(A). In addition, the trust agreements for each of the three trusts provided that, while the beneficiary of the trust was under age 21, the trustee had discretionary authority to distribute income to the income beneficiary of each trust for that beneficiary’s s. In Year 1 and Year 2, each of the three beneficiaries for the three trusts was under age 21. In Year 1 and Year 2, the trustee of each of the three trusts did not distribute currently
PLR-104519-13
3

all of the income of the trust to the beneficiary. In Year 3 and Year 4, the beneficiary for two of the three trusts was under age 21 for at least part of the year. In Year 3 and Year 4, the trustee of two of the three trusts did not distribute currently all of the income of the trust to the beneficiary. As a result, X's S corporation election terminated on Date 4.

X represents that X and the trustees and beneficiaries of the three trusts intended that each of the trusts be treated as a QSST. Though the instruments for each of the Trusts do not require the trustees of the Trusts to distribute all of the Trusts’ income (within the meaning of § 643(b)) to each trust’s current income beneficiary while the beneficiary is under age 21, X represents that no tax avoidance or retroactive tax planning was intended by the inadvertent failure to distribute a portion of each trust’s income.

X has represented that X has been treated as an S corporation since Date 2.
Furthermore, for Year 1 and all subsequent taxable years, X has represented that the three trusts were treated by their beneficiaries as QSSTs effective as of the trusts’ respective dates of formation. Furthermore, X represents that each of the three trusts’ beneficiaries reported all of their respective shares of X’s income on their individual income tax returns for Year 1 and all subsequent taxable years.

X's S corporation election would also have terminated (if it had not already terminated on Date 4) on Date 5, Date 6, and Date 7 due to the continued failure of the trusts to distribute all of their income to their respective beneficiaries pursuant to § 1361(d)(3)(B).

The Trusts each have taken corrective action by making remedial distributions.
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.

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)(B) provides that, for purposes of subchapter S, 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
PLR-104519-13
4

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 all of which 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 may be an S corporation shareholder.

Section 1361(d)(1) provides that, in the case of a qualified subchapter S trust 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)(7)(i) of the Income Tax Regulations 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 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 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 the termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to such beneficiary.

Section 1361(d)(3)(B) provides that for purposes of § 1361(d), the term “qualified subchapter S trust” means a trust 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 1361(d)(4) provides that if any QSST ceases to meet any requirement of § 1361(d)(3)(B) but continues to meet the requirements of § 1361(d)(3)(A) (regarding the terms of the trust), the provisions of § 1361(d) shall not apply to such trust as of the first day of the first taxable year beginning after the first taxable year for which it failed to meet the requirements of § 1361(d)(3)(B).

Section 1.1361-1(j)(6)(ii) 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).
PLR-104519-13
5

Section 1.1361-1(j)(6)(iii)(E) provides that, if a corporation’s S election terminates because of a late QSST election, the corporation may request inadvertent termination relief under § 1362(f).

Section 1362(d)(2) provides that (A) in general, 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 and (B) any termination under § 1362(d)(2) shall be effective on and after the date of cessation.

Section 1362(f) provides 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) or (3), (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 (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) as may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in the ineffectiveness or termination, the corporation will be treated as an S corporation during the period specified by the Secretary.

CONCLUSIONS

Based solely on the facts submitted and the representations made, we conclude that the termination of X's S corporation election on Date 4 was inadvertent within the meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 4 and thereafter, provided X's S corporation election was valid and provided that the election was not terminated under § 1361(d) as a result of an event or a transaction other than those described in this ruling. We further hold that the three trusts will be treated as QSSTs from Date 4 and thereafter, provided that each of the three trusts meets the requirements of § 1361(d)(3)(A), and the beneficiary of each of the three trusts is treated, for purposes of § 678, as the owner of the above-referenced number of shares of X stock.

The shareholders of X must include their pro-rata share of the separately stated and nonseparately computed items of X as provided in § 1366, make any adjustments to basis as provided in § 1367, and take into account any distributions made by X as
PLR-104519-13
6

provided in § 1368. If X or its shareholders fail to treat themselves as described above, this ruling is null and void.

Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code. In particular, we express or imply no opinion on whether X is otherwise eligible to be an S corporation, or on whether the three trusts are otherwise eligible to be QSSTs.

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.

Pursuant to a power of attorney on file, a copy of this letter is being sent to X's authorized representative.

Sincerely,

David R. Haglund
David R. Haglund
Chief, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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