Missing successor-trust QSST election receives S termination relief

Plain-English summary

S corporation shares were held in a qualified subchapter S trust during the income beneficiary's life. After the beneficiary died, the original trust remained a permitted shareholder under the two-year post-death rule until the shares transferred to a successor trust. The successor trust was eligible for QSST status, but its beneficiary did not make the election on time, terminating the corporation's S election on the transfer date. The IRS found the termination inadvertent and allowed S status to continue, provided the beneficiary files a retroactive QSST election within 120 days. It did not decide whether the corporation or successor trust otherwise qualified.

Ruling snapshot

• Question: Can the corporation retain S status after shares moved from a post-death QSST to a successor trust without a timely QSST election?
• Outcome: Approved, if the retroactive QSST election is filed within 120 days.
• Key authorities: IRC §§ 1361(c) and (d), and 1362(f); Treas. Reg. § 1.1361-1(h) and (j).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201516016 Third Party Communication: None
Release Date: 4/17/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------- ------------------------------ ------------
------------------------------------- Telephone Number:
----------------------------- --------------------
------------------------------- Refer Reply To:
CC:PSI:B01
PLR-124191-14
Date:
December 05, 2014

LEGEND:

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

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

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

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

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

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

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

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

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

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

Dear------------
PLR-124191-14 2

This responds to a letter dated June 2, 2014, and subsequent correspondence,
submitted on behalf of X, requesting inadvertent termination relief pursuant to § 1362(f)
of the Internal Revenue Code (the Code).

Facts

The information submitted states that X was incorporated on Date 1, under the laws of
State. Effective Date 2, X elected to be taxed as an S corporation.

During A’s life, A owned shares in X through Trust 1, a qualified subchapter S trust
(QSST). A died on Date 3. Trust 1 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.

Pursuant to the terms of Trust 1, after A’s death, the X shares were transferred from
Trust 1 to Trust 2 on Date 4. X represents that Trust 2 is eligible to elect to be a QSST.
However, a QSST election was not timely made for Trust 2.

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. Additionally, X represents that X and its shareholders have filed their federal
income tax returns consistent with having a valid S corporation election in effect for X.
X and its shareholders have agreed to make any adjustments consistent with the
treatment of X as an S corporation as may be required by the Secretary
with respect to the period specified by § 1362(f).

Law and Analysis

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)
PLR-124191-14 3

immediately before the death of the deemed owner and that continues in existence after
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 purposes of §§ 1366,
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.
PLR-124191-14 4

Conclusion

Based solely on the facts submitted and representation made, we conclude X’s S
election terminated on Date 4 when Trust 2 became a shareholder. We also conclude
that the termination of X’s S corporation election was inadvertent within the meaning of
§ 1362(f).

Accordingly, under § 1362(f), X will be treated as continuing to be an S corporation from
Date 4 and thereafter, provided that X’s S election is valid and not otherwise terminated
under § 1362(d).

This relief is contingent upon B filing a QSST election for Trust 2 effective Date 4 within
120 days from the date of this letter. A copy of this letter should be attached to the
election.

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 or Trust 2 to be a QSST. 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,



                                   Joy C. Spies
                                   Senior Technician Reviewer, Branch 1
                                   (Passthroughs & Special Industries)

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

cc: