IRS provides relief for an inadvertent S corporation termination

Plain-English summary

An S corporation's shareholder transferred shares to a grantor trust, and the trust later became irrevocable when the deemed owner died. The trust was eligible to hold S corporation stock, but its beneficiary failed to make the required qualified subchapter S trust election on time. The IRS treated the resulting S election termination as inadvertent and allowed the corporation to continue being treated as an S corporation from the termination date, subject to a QSST election being filed within 120 days. The ruling also required the corporation and its shareholders to maintain consistent S corporation treatment and make any required adjustments.

Ruling snapshot

• Question: Can the corporation retain S corporation status after an untimely QSST election caused an inadvertent termination?
• Outcome: Approved.
• Key authorities: IRC §§ 1361 and 1362; Treas. Reg. §§ 1.1361-1 and 1.1362-4.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201404003
Third Party Communication: None
Release Date: 1/24/2014
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B02
PLR-113745-13
Date:
July 23, 2013

X = ------------------------
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State = ------------
D1 = ----------------------
D2 = ------------------
D3 = ---------------------------
D4 = ---------------------------
Trust = ----------------------------------------
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A = --------------------------------

B = ---------------------------
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Dear ---- -------:

This responds to a letter dated March 20, 2013, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated under the laws of State and elected to be an S corporation effective on or about D1. On D2, A, a shareholder of X, transferred shares of X to Trust, a revocable trust treated as a wholly-owned grantor trust under §§ 671 and 676. On D3, A died and Trust became irrevocable. Trust qualified as an S corporation shareholder under § 1361(c)(2)(A)(ii).

X represents that Trust was eligible to elect qualified subchapter S trust (QSST) treatment under § 1361(d). However, B, the sole beneficiary of Trust, inadvertently failed to timely make a QSST election. Therefore, X’s S election terminated on D4.
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X represents that X and each of its shareholders have filed consistently with the treatment of X as an S corporation since D1. X represents that the termination was not motivated by tax avoidance or retroactive tax planning. 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.

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)(B) provides that 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 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(c)(2)(A)(ii) and § 1.1361-1(h)(1)(ii) provide that, for purposes of § 1361(b)(1)(B), a trust that is described in § 1361(c)(2)(A)(i) immediately before the death of the deemed owner and that continues in existence after such death is a permitted S corporation shareholder, but only for the two-year period beginning on the day of the deemed owner's death. Section 1.1361-1(h)(3)(i)(B) provides that if stock is held by a trust described in § 1.1361-1(h)(1)(ii), the estate of the deemed owner is generally treated as the shareholder as of the day of the deemed owner's death.

Section 1361(d)(1) provides that in the case of a QSST for which a beneficiary makes an election under § 1361(d)(2), the trust is treated as a trust described in § 1361(c)(2)(A)(i), and for purposes of § 678(a), the beneficiary of the trust shall be treated as the owner of that portion of the trust that 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 may elect to have § 1361(d) apply. 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).

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
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and after the date of cessation.

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) 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.

Based solely on the facts submitted and the representations made, we conclude that X’s S corporation election terminated on D3, because of the inadvertent failure of the beneficiary of Trust to make the QSST election, and that this termination of X’s S election was an inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from D3 and thereafter, provided X’s S corporation election was valid and not otherwise terminated under § 1362(d).

This ruling is contingent upon Trust’s beneficiary filing a QSST election for Trust with an effective date of D4, with the appropriate service center within 120 days of the date of this ruling. A copy of this letter should be attached to the QSST election. If X or its shareholders fail to treat X as described above, this letter ruling will be null and void.

Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the Code, including whether X is a small business corporation under § 1361(b), or whether Trust is a QSST within the meaning of § 1361(d)(3).
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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. Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s authorized representative.

Sincerely,

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

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

cc: