Missing QSST election treated as inadvertent S termination

Plain-English summary

A trust acquired shares of an S corporation and met the substantive qualified subchapter S trust requirements, but its income beneficiary failed to file the QSST election. The trust therefore was not a permitted shareholder, causing the corporation's S election to terminate on the transfer date. The corporation represented that the failure was not tax-motivated and that its filings consistently treated it as an S corporation. The IRS ruled that the termination was inadvertent and treated the corporation as continuously maintaining S status. Relief is conditioned on the trust beneficiary filing the QSST election effective on the original transfer date within 120 days, with the ruling attached. The IRS did not otherwise determine the corporation's S eligibility or the trust's QSST eligibility.

Ruling snapshot

• Question: Can the corporation retain continuous S status after a trust beneficiary missed the QSST election?
• Outcome: Approved
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201444012
Third Party Communication: None
Release Date: 10/31/2014
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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-------------------------, ID No. ------------
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Telephone Number:
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Refer Reply To:
CC:PSI:03
PLR-106526-14
Date:
July 18, 2014

LEGEND

X = -------------------------------------------------------------------------------------------------------
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D1 = -----------------------

D2 = --------------------------

D3 = ---------------------

Trust = -------------------------------------------------------------------------------------------------------
------------------------

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

This letter responds to a letter dated January 31, 2014, and subsequent correspondence, submitted on behalf of X by its authorized representative requesting a ruling under § 1362(f) of the Internal Revenue Code (“Code”).

FACTS

X was incorporated on D1 and elected to be an S corporation effective D2. On D3, Trust became a shareholder of X. X represents that Trust satisfies the qualified subchapter S trust (“QSST”) requirements under § 1361(d)(3). However, the income beneficiary of Trust failed to file an election for Trust to be a QSST effective D3. Therefore, Trust was not a permitted shareholder.

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X represents that the termination was not motivated by tax avoidance or retroactive tax planning. X further represents that X and its shareholder have filed consistently with the treatment of X as an S corporation since D1. X and its shareholder 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) provides that the term “small business corporation” means a domestic corporation which is not an ineligible corporation and which does not (A) have more than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more than one class of stock.

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)(2)(A) provides that a beneficiary of a QSST (or his legal representative) may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that an election under § 1361(d)(2) shall be effective up to 15 days and 2 months before the date of the election.

Section 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current income beneficiary of the trust must make the election under § 1361(d)(2) by signing and filing with the service center where the corporation files its income tax return the applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

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Section 1362(d)(2)(A) provides that an election under § 1362(a) will 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.

Section 1362(f) provides, in part, 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 the 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 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 the corporation at any time during the period specified pursuant to § 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 with respect to such period, then, notwithstanding the circumstances resulting in the termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that X’s S corporation election terminated on D3, when stock in X was transferred to Trust. We further conclude that the termination was inadvertent 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 that X’s S corporation election was otherwise valid and has not otherwise terminated under § 1362(d).

This ruling is conditioned on the beneficiary of Trust filing a QSST election for Trust, effective D3, with the appropriate service center within 120 days of the date of this letter. A copy of this letter should be attached to the QSST election.

Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the facts described above under any other provisions of the Code, including X’s eligibility to be a valid S corporation, or Trust’s eligibility to be a QSST.

PLR-106526-14
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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.

In accordance with a power of attorney on file with this office, we are sending a copy of this letter to X’s authorized representative.

Sincerely,

Holly Porter
Branch Chief, Branch 3
(Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes

cc: