IRS restores S corporation status after missed QSST elections

Plain-English summary

An S corporation's shares were transferred to six trusts, but the beneficiaries did not make the required qualified subchapter S trust elections on time. Because the trusts were therefore ineligible shareholders, the corporation's S election terminated. The IRS found that the termination was inadvertent and allowed the corporation, including its successor after a tax-free reorganization, to continue being treated as an S corporation if each beneficiary filed a QSST election within 120 days. The ruling did not decide whether the trusts otherwise qualified as QSSTs or whether the corporations were otherwise eligible for S status.

Ruling snapshot

• Question: Could the corporation's terminated S election be treated as continuing after the missed QSST elections?
• Outcome: Approved, subject to filing the six QSST elections within 120 days.
• Key authorities: IRC §§ 1361, 1362, and 368; Treas. Reg. § 1.1362-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201408005 Third Party Communication: None
Release Date: 2/21/2014 Date of Communication: Not Applicable
Index Number: 1362.02-00
Person To Contact:
------------------------------------- -----------------------------, ID No. -------------
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------------------------------- Telephone Number:
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Refer Reply To:
CC:PSI:02
PLR-118915-13
Date:
August 29, 2013

Legend
Company 1 = --------------------------------------------------------------------------------------------
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Company 2 = --------------------------------------------------------------------------------------------
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State = ----------
Date 1 = ---------------------------
Date 2 = ----------------------
Date 3 = --------------------
Date 4 = --------------
Trust 1 = --------------------------------------------------------------------------------------------
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Trust 2 = --------------------------------------------------------------------------------------------
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Trust 3 = --------------------------------------------------------------------------------------------
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Trust 4 = --------------------------------------------------------------------------------------------
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Trust 5 = --------------------------------------------------------------------------------------------
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Trust 6 = --------------------------------------------------------------------------------------------
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Dear ----------------:

  This letter responds to a letter dated April 5, 2013, and subsequent

correspondence, submitted on behalf of Company 2 by Company 2’s authorized
representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

PLR-118915-13 2

    Company 1 incorporated in State on Date 1, and elected to be an S corporation

effective Date 2. On Date 3, shares of Company 1 stock were transferred to Trust 1,
Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6. Company 2 represents Trust 1, Trust 2,
Trust 3, Trust 4, Trust 5, and Trust 6 were eligible to be qualified subchapter S trusts
(QSSTs) within the meaning of § 1361(d)(3) and have been treated as though a timely
QSST election had been made. However, neither the trustees and the current income
beneficiaries of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 nor the IRS have
been able to confirm the filing of the QSST elections for any of the trusts. Therefore,
Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 were not eligible shareholders,
and, as a result, Company 1’s S corporation election terminated on Date 3.

   On Date 4, Company 2 represents that Company1 restructured its businesses by

creating Company 2, engaging in a tax-free reorganization under § 368(a)(1)(F). As a
result of this restructure, Company 2 is treated for Federal income tax purposes as a
continuation of Company 1.

   Company 2 represents that the circumstances resulting in the termination of

Company 1’s S corporation election were inadvertent and were not motivated by tax
avoidance or retroactive tax planning. Company 2 and its shareholders have agreed to
make any adjustments consistent with the treatment of Company 1 and Company 2, as
its successor, as an S corporation as may be required by the Secretary with respect to
the period specified by § 1362(f).

    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
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 a shareholder.
Section 1361(c)(2)(A)(ii) provides that, for purposes of § 1361(b)(1)(B), 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 may be a shareholder, but only for the
2-year period beginning on the day of the deemed owner’s death.

   Section 1361(d)(1) provides that a QSST whose beneficiary makes an election

under section 1362(d)(2) will be treated as a trust described in section 1361(c)(2)(A)(i),
and the QSST’s beneficiary will be treated as the owner (for purposes of section 678(a))
of that portion of the QSST’s S corporation stock to which the election under section
1361(d)(2) applies. Under section 1361(d)(2)(A), a beneficiary of a QSST may elect to
have section 1361(d) apply. Under section 1361(d)(2)(D), this election will be effective
up to 15 days and two months before the date of the election.

    Section 1361(d)(3) defines a QSST as a trust (A) the terms of which require that

(i) during the life of the current income beneficiary, there shall be only one 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 beneficiary in the trust shall terminate on the earlier of the 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 that beneficiary;
and (B) all of the income (within the meaning of section 643(b) of which is distributed (or
required to be distributed) currently to one 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 1st day of the 1st 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) by any corporation

was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the
circumstances resulting in such termination were inadvertent, (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, and (4) the corporation for which 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
termination, such corporation shall be treated as an S corporation during the period
specified by the Secretary.

   Section 1.1362-4(b) provides, in relevant part, that for purposes of § 1.1362-4(a),

the determination of whether a termination was inadvertent is made by the
Commissioner. The corporation has the burden of establishing that under the relevant
facts and circumstances the Commissioner should determine that the termination was
inadvertent. The fact that the terminating event was not reasonably within the control of
the corporation and was not part of a plan to terminate the election, or the fact that the
terminating event or circumstance took place without the knowledge of the corporation,
notwithstanding its due diligence to safeguard itself against such an event or
circumstance, tends to establish that the termination was inadvertent.

PLR-118915-13 4

   Section 1.1362-4(d) provides, in part, that the Commissioner may require any

adjustments that are appropriate. In general, the adjustments should be consistent with
the treatment of the corporation as an S corporation during the period specified by the
Commissioner.

   Based solely on the facts submitted and representations made, we conclude that

Company 1’s S corporation election terminated on Date 3, when stock in Company 1 was
transferred to Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 because the
beneficiaries of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 failed to timely file
the required QSST election under § 1361(d)(3). We further conclude that the
termination was inadvertent within the meaning of § 1362(f). Pursuant to the provisions
of § 1362(f), Company 1 and Company 2, as a successor of Company 1, will be
treated as continuing to be an S corporation on and after Date 3, provided that the
beneficiaries of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 each file a QSST
election with the appropriate service center within 120 days of this letter to be effective
Date 3. A copy of this letter should be attached to each QSST election.

    Except as expressly provided herein, we express or imply no opinion concerning

the tax consequences of any aspect of any transaction or item discussed or referenced
in this letter. Specifically, we express or imply no opinion regarding whether Company 1
or Company 2 are otherwise eligible to be treated as an S corporation or whether Trust 1,
Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 are eligible to be treated as QSSTs. 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. Pursuant to a power of attorney
on file, a copy of this letter is being sent to Company 2’s authorized representative.

                                    Sincerely,



                                    Bradford R. Poston
                                    Senior Counsel, Branch 2
                                    (Passthroughs & Special Industries)

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

cc: