Expired QSST grace period causes inadvertent S corporation termination

Plain-English summary

Three qualified subchapter S trusts held stock in an S corporation for one income beneficiary. After that beneficiary died, the trusts remained permissible shareholders for two years, but became ineligible when that statutory grace period ended. Their trustees later transferred the stock to another trust represented to be a QSST. The IRS found that the resulting termination was inadvertent and treated the corporation as continuously maintaining S status, provided its election was otherwise valid and had not otherwise terminated.

Ruling snapshot

• Question: Was the S corporation termination caused by three trusts remaining shareholders after their two-year post-death grace period inadvertent?
• Outcome: Approved. The corporation retained continuous S status after the trusts transferred their stock to an eligible QSST.
• Key authorities: IRC §§ 1361(c), 1361(d), and 1362(f); Treas. Reg. § 1.1361-1(h), (j)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201420005
Third Party Communication: None
Release Date: 5/16/2014
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-133227-13
Date:
December 23, 2013

LEGEND:

X = -------------------------------------------------------------------------------------------------------------------
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A = --------------------

Trust 1 = -------------------------------------------------------------------------------------------------------------------
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Trust 2 = -------------------------------------------------------------------------------------------------------------------
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Trust 3 = -------------------------------------------------------------------------------------------------------------------
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Trust 4 = -------------------------------------------------------------------------------------------------------------------
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State = ------------

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

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

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

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

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

This responds to a letter dated July 26, 2013, and subsequent correspondence, 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 on Date 1, and elected to be an S corporation effective Date 2. Trust 1, Trust 2 and Trust 3, each of which was a qualified subchapter S trust (QSST) under § 1361(d)(1) for which A was the sole income beneficiary, were shareholders of X.

On Date 3, A died. Trust 1, Trust 2 and Trust 3 each continued to qualify as a permissible S corporation shareholder under § 1.1361-1(j)(7)(ii) of the Income Tax Regulations for the 2-year period beginning on the day of the deemed owner’s death and ending on Date 4.

On Date 4, Trust 1, Trust 2 and Trust 3 each became an ineligible shareholder of X and X’s election to be an S corporation terminated. On Date 5, the trustees of each of Trust 1, Trust 2 and Trust 3 distributed each Trust’s stock in X to Trust 4, which X represents is a QSST. X represents that the circumstances resulting in the termination of X’s S corporation election were inadvertent and were 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) 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 the purposes of §1362(b)(1)(B), a trust all of which is treated (under title 26, subtitle A, chapter 1, subchapter J, part I, subpart E of the United States Code) as owned by an individual who is a citizen or resident of the United States may be a shareholder of an S corporation.

Section 1361(c)(2)(A)(ii) and §1.1361-1(h)(1)(ii) of the Income Tax regulations 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
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such death is a permitted shareholder, but only for the two-year period beginning on the day of the deemed shareholder’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 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) 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 1.1361-1(j)(7)(ii) provides that if, upon the death of an income beneficiary, the trust continues in existence, continues to hold S corporation stock but no longer satisfies the QSST requirements, is not a qualified subpart E trust, and does not qualify as an ESBT, then, solely for purposes of section 1361(b)(1), as of the date of the income beneficiary’s death, the estate of that income beneficiary is treated as the shareholder of the S corporation with respect to which the income beneficiary made the QSST election. The estate ordinarily will cease to be treated as the shareholder for purposes of section 1361(b)(1) upon the earlier of the transfer of that stock by the trust or the expiration of the 2-year period beginning on the day of the income beneficiary’s death. During the period that the estate is treated as the shareholder for purposes of section 1361(b)(1), the trust is treated as the shareholder for purposes1366, 1367, and 1368.

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 the termination, steps were taken so that the corporation is a small business corporation; and (4) the corporation, and each person who was a shareholder of the corporation at any time during the period specified under § 1362(f), agrees to make the adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary for that period, then, notwithstanding the circumstances resulting in such termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.
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Based solely on the information submitted and the representations made, we conclude that X’s S corporation election terminated on Date 4, when Trust 1, Trust 2 and Trust 3 became ineligible shareholders. We further conclude that the termination of X’s S corporation election was an inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date 4 and thereafter, provided that X’s S corporation election was otherwise valid and has not otherwise terminated under § 1362(d).

Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the transactions described above under any other provision of the Code. Specifically, we express or imply no opinion regarding whether X is otherwise eligible to be an S corporation. This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent. In accordance with the power of attorney on file with this office, a copy of this letter is being sent to X’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: