Missing QSST elections receive inadvertent S termination relief

Plain-English summary

An S corporation transferred shares to two trusts that otherwise met the qualified subchapter S trust requirements. The trusts' sole income beneficiaries did not timely make QSST elections, making the trusts ineligible shareholders and terminating the corporation's S election. The corporation and shareholders had continued to report as an S corporation and represented that the failure was inadvertent rather than tax planning. The IRS granted inadvertent-termination relief, provided both beneficiaries file retroactive QSST elections within 120 days. It did not decide whether the trusts or corporation otherwise met their qualification requirements.

Ruling snapshot

• Question: Can the corporation retain S status after two trust beneficiaries failed to make timely QSST elections?
• Outcome: Approved, if both QSST elections are filed within 120 days with the original effective date.
• Key authorities: IRC §§ 1361(d) and 1362(d) and (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: 201516029 Third Party Communication: None
Release Date: 4/17/2015 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
------------------------- ------------------------, ID No. ----------------
--------------------------------------------------- Telephone Number:
----------------------- --------------------
------------------------------ Refer Reply To:
CC:PSI:B3
PLR-126652-14
Date:
December 18, 2014

LEGEND

Company = -----------------------------------
----------------------

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

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

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

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

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

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

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

m = -----

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

 This letter responds to a letter dated June 25, 2014, submitted on behalf of

Company, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS
PLR-126652-14 2

   According to the information submitted, Company was incorporated under the

laws of State on Date 1, and elected to be an S corporation effective Date 1. On Date 2,
m shares of Company stock were transferred to Trust 1, and m shares of Company
stock were transferred to Trust 2. Company represents that since Date 2, Trust 1 and
Trust 2 have met the definition of a “qualified subchapter S trust” (QSST) under
§ 1361(d)(3). However, the sole income beneficiary of Trust 1, A, and the sole income
beneficiary of Trust 2, B, did not make a timely QSST election under § 1361(d)(2).
Therefore, Trust 1 and Trust 2 were not permissible shareholders on Date 2 and
thereafter. As a result, Company’s S corporation election terminated on Date 2.

   Company represents that there was no intent to terminate Company’s S

corporation election and that the termination as inadvertent and not motivated by tax
avoidance or retroactive tax planning. Company and its shareholders have treated
Company as an S corporation since Date 2. In addition, Company and its shareholders
agree to make any adjustments consistent with the treatment of Company as an S
corporation as may be required by the Secretary.

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, for purposes of subchapter S, 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)(i) provides that, for the purposes of § 1362(b)(1)(B), a trust

all of which is treated (under subpart E of part I of subchapter J of chapter 1) as owned
by an individual who is a citizen or resident of the United States, may be an S
corporation shareholder.

   Section 1361(d)(1) provides that in the case of a QSST 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 1361(d)(2)(A) provides that a beneficiary of a QSST (or his legal

representative) may elect to have § 1361(d) apply.
PLR-126652-14 3

    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 with which the corporation files its income tax return
the applicable form or statement including the information listed in § 1361-1(j)(6)(ii).

  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 1362(d)(2)(A) provides that an election under § 1362(a) shall be

terminated whenever (at any time on or after the 1st day of the 1st taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation.

   Section 1362(f) provides that if (1) an election under § 1362(a) by any

corporation was terminated under § 1362(d)(2) or (3), or (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 such
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 such corporation at any time
during the period specified pursuant to § 1362(f), agrees to make such adjustments
(consistent with the treatment of such corporation as an S corporation) as may be
required by the Secretary with respect to such period, then, notwithstanding the
circumstances resulting in such termination, such corporation shall be treated as an S
corporation during the period specified by the Secretary.

CONCLUSION

    Based solely on the facts submitted and representations made, we conclude that

Company’s S corporation election terminated on Date 2 because A and B failed to make
a QSST election under § 1361(d)(2) for Trust 1 and Trust 2 respectively. We also
conclude that the termination of Company’s S corporation election was inadvertent
within the meaning of § 1362(f).

    Accordingly, under § 1362(f), Company will be treated as continuing to be an S

corporation from Date 2 and thereafter, provided that Company’s S corporation election
was valid and was not otherwise terminated under § 1362(d), and provided that A and B
file an election under § 1361(d)(2)(A) for Trust 1 and Trust 2 with an effective date of
Date 2 with the appropriate service center within 120 days from the date of this letter. A
copy of this letter should be attached to the election under § 1361(d)(2)(A).

   Except as expressly provided herein, we express or imply no opinion concerning

the tax consequences of any aspect of any transaction or item discussed or referenced
PLR-126652-14 4

in this letter. Specifically, we express or imply no opinion as to whether Trust 1 and
Trust 2 are otherwise eligible to be QSSTs or whether Company is otherwise eligible to
be an S corporation for federal tax purposes.

  This ruling is directed only to the taxpayer requesting 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 your authorized representatives.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

                                  Sincerely,



                                  Richard T. Probst
                                  Senior Technician Reviewer, Branch 3
                                  Office of Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: