Corporation received S election relief after twelve trusts were modified

Plain-English summary

Twelve testamentary trusts held stock when a corporation elected S status. Each trust beneficiary could appoint trust income to someone else, which prevented the trusts from qualifying as qualified subchapter S trusts and made the corporation's election ineffective. A state court later modified every trust to remove that appointment power. The IRS found the invalid election inadvertent, concluded that the modified trusts met the QSST requirements, and treated the corporation as an S corporation continuously from its original election date. Relief depended on the election otherwise being valid and not terminating for another reason.

Ruling snapshot

• Question: Could a corporation receive inadvertent-invalid-election relief after twelve shareholder trusts initially failed the QSST requirements?
• Outcome: Approved. The corporation was treated as an S corporation from its original election date after the trusts were judicially modified.
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. § 1.1361-1(j)(2)(iii)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201426001
Third Party Communication: None
Release Date: 6/27/2014
Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.01-02
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B02
PLR-100784-14
Date:
March 12, 2014

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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Trust 5 = --------------------------------------------------------------------------------------------
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Trust 6 = --------------------------------------------------------------------------------------------
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Trust 7 = --------------------------------------------------------------------------------------------
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Trust 8 = --------------------------------------------------------------------------------------------
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Trust 9 = --------------------------------------------------------------------------------------------
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Trust 10 = --------------------------------------------------------------------------------------------
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Trust 11 = --------------------------------------------------------------------------------------------
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Trust 12 = --------------------------------------------------------------------------------------------
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State = -------------

Court = --------------------------------------------

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

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

Date 3 = ---------------------
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Date 4 = ----------------------------------

Dear------------

This responds to a letter dated December 31, 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. Effective Date 3, X elected to be taxed as an S corporation.

Prior to X’s S election on Date 3, shares of X were held by A, an individual. On Date 1, A died. Pursuant to the terms of A’s will, shares of X stock were transferred from A’s estate to twelve (12) separate trusts for each of A’s grandchildren on Date 2. These trusts include Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6, Trust 7, Trust 8, Trust 9, Trust 10, Trust 11, and Trust 12 (collectively the “Testamentary Trusts”).

Under the terms of each of the Testamentary Trusts, as provided in A’s will, the Testamentary Trusts were each eligible to elect to be treated as Qualified Subchapter S Trusts (QSSTs) except that each beneficiary had a limited power to appoint the income from their respective Testamentary Trust to someone other than himself. On Date 4,
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Court of State approved the petition filed on behalf of the Testamentary Trusts and entered an Order modifying each Testamentary Trust to remove each beneficiary’s limited power to appoint the income of their respective Testament Trust to someone other than himself.

X represents that X and X’s shareholders have filed tax returns consistent with X being an S corporation. X further represents that the circumstances resulting in X’s invalid S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and each person who was or is a shareholder of X at any time since Date 3 agree to make any adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary with respect to such period.

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 all of which is treated (under subpart E of part 1 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(d)(1) provides that a QSST whose beneficiary makes an election under § 1361(d)(2), will be treated as a trust described in § 1361(c)(2)(A)(i) and the beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) 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 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 income 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 § 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 1.1361-1(j)(2)(iii) provides, that if, under the terms of the trust, a person (including the income beneficiary) has a special power to appoint, during the life of the
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of the income beneficiary, trust income or corpus to any person other than the current income beneficiary, the trust will not qualify as a QSST.

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.

Based solely on the information submitted and the representations made, we conclude that X’s S corporation election was ineffective on Date 3 because the Testamentary Trusts were ineligible shareholders as each trust beneficiary possessed a limited power to appoint the income to someone other than themselves and thus each trust did not qualify as a QSST. We further conclude that the ineffectiveness of X’s S corporation election constituted an inadvertent invalid election within the meaning of § 1362(f). Each trust, as modified by Court, meets the requirements of § 1361(d)(3). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date 3 and thereafter, provided that X’s S corporation election was otherwise valid and has not otherwise terminated under § 1362(d).
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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,

Melissa C. Liquerman
Chief, Branch 2
(Passthroughs & Special Industries)

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

cc: