Late QSST election does not end S corporation status

Plain-English summary

An S corporation's shares passed to a testamentary trust after a shareholder died. The trust remained an eligible shareholder for two years but continued holding the stock after that period without a qualified subchapter S trust election, causing the S election to terminate. The IRS found the termination inadvertent because the corporation and its shareholders consistently filed as an S corporation, the missed election was not tax-motivated, and they agreed to any required adjustments. It ruled that the corporation would continue to be treated as an S corporation from the termination date forward, assuming it otherwise remained eligible. Relief was conditioned on the trustee filing a QSST election effective on the termination date within 120 days and attaching a copy of the ruling.

Ruling snapshot

• Question: Could an S corporation receive inadvertent-termination relief after a trust failed to make a timely QSST election?
• Outcome: Approved, conditioned on filing the QSST election within 120 days
• Key authorities: IRC §§ 1361(c)(2), 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: 201505034 Third Party Communication: None
Release Date: 1/30/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------- -----------------------, ID No. -------------------
------------------------------ ---------------------------------------------------
----------------------------------------- Telephone Number:
---------------------------------- ----------------------
Refer Reply To:
CC:PSI:B01
PLR-126289-14
Date:
September 29, 2014

                                                 Legend

X = -------------------------------

Trust 1 = -------------------------------

Trust 2 = --------------------------
------------------------

State = -----------

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

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

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

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

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

Date 6 = ------------------------

Date 7 = --------------------------

A = ---------------------

B = --------------------------------
--------------------------

PLR-126289-14 2

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

  This responds to a letter dated June 30, 2014, 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 formed in State on Date 1 and made

an election to be treated as an S corporation effective Date 2. On Date 3, A and A’s
spouse, B created Trust 1, a revocable trust treated as a wholly-owned grantor trust
under §§ 671 and 676. On Date 4, A died. Pursuant to the terms of A’s will and Trust
1, shares of X were transferred to Trust 2 on Date 5. Trust continued to qualify as an S
corporation shareholder under § 1361(c)(2)(A)(ii) until Date 6, two years after Date 5.
Trust 2, however, continued to hold X stock. As such, X's S corporation election
terminated on Date 6 when Trust 2 ceased to be an eligible S corporation shareholder.
B, Trust 2’s sole beneficiary, died on Date 7, and Trust 2 terminated.

   X represents that X and each of its shareholders have filed consistently with the

treatment of X as an S corporation since Date 2. X further represents that the failure to
properly file the QSST election for Trust 2 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)(iii) provides that a trust may be an S corporation

shareholder with respect to stock transferred to it pursuant to the terms of a will, but
only for the 2-year period beginning on the day on which such stock is transferred to it.

   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

PLR-126289-14 3

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
and after the date of cessation.

    Section 1362(f) provides 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 election to be treated as an S corporation terminated on Date 6 and that this
termination was inadvertent within the meaning of § 1362(f). We further conclude that,
pursuant to the provisions of § 1362(f), X will continue to be treated as being an S
corporation from Date 6 and thereafter, provided that X is otherwise eligible to be an S
corporation and provided that the election was not otherwise terminated under
§ 1362(d).

    This ruling is conditioned upon the trustee of Trust 2 filing, with the appropriate

service center, a QSST election effective Date 6 for Trust 2. The QSST election must
be filed within 120 days following the date of this letter and a copy of this letter should
be attached to the election.

   Except as specifically ruled above, we express no opinion concerning the federal

tax consequences of the transactions described above under any other provisions of the
Code. Specifically, we express no opinion regarding X’s eligibility to be an S
corporation. Further, we express no opinion on whether Trust 2 is otherwise eligible to
be a QSST.

PLR-126289-14 4

  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.

                                   Sincerely,


                                   Joy C. Spies
                                   Joy C. Spies
                                   Senior Technician Reviewer, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)