Invalid QSST election receives inadvertent S corporation termination relief

Plain-English summary

An S corporation shareholder placed stock in a revocable trust before death, and part of that stock later passed to another trust. The new trust's beneficiary failed to file a valid qualified subchapter S trust election when the stock was transferred. The corporation and shareholders nevertheless reported consistently with continued S corporation and QSST treatment, and represented that the error was unintentional and unrelated to tax avoidance or retroactive planning. The IRS ruled that the resulting S election termination was inadvertent under section 1362(f). The corporation could retain S status from the transfer date forward if the beneficiary filed a QSST election effective on that date within 120 days.

Ruling snapshot

• Question: Can the corporation retain S status after a trust beneficiary failed to file a valid QSST election for transferred shares?
• Outcome: Approved
• Key authorities: IRC §§ 643(b), 678(a), 1361, 1362(f); Treas. Reg. § 1.1361-1(j)(6)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201528028                                              Third Party Communication: None
Release Date: 7/10/2015                                        Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.02-03
                                                               Person To Contact:
                                                               --------------, ID No. ----------------
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                                                               Telephone Number:
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                                                               --------------------
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                                                               Refer Reply To:
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                                                               CC:PSI:B01
                                                               PLR-139132-14
                                                               Date:
                                                               April 08, 2015




LEGEND

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

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

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

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

Trust 3 =         ------------------------------------------

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

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

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

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

Year      =       ------

State     =       -------------
PLR-139132-14                                 2


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

This responds to a letter signed October 15, 2014, submitted on behalf of X by X’s
authorized representative, requesting relief under § 1362(f) of the Code.

FACTS

According to the information submitted and representations within, X was incorporated
on Date 1 under the laws of State and elected to be taxed as an S corporation effective
Date 2.

A, a shareholder of X, transferred his shares in X to Trust 1, a revocable trust, prior to
his death on Date 3. Following the death of A, a portion of the X stock held by Trust 1
was distributed to Trust 2 on Date 4. B is the beneficiary of Trust 2. Trust 2 is a
surviving trust of a merger between Trust 2 and Trust 3 which was accomplished prior
to Date 4. B failed to file a valid QSST election for Trust 2 effective Date 4.

X represents that the inadvertent invalid QSST election was discovered in Year. X
represents that the errors made in filing the QSST election for Trust 2 were
unintentional and were not motivated by tax avoidance or retroactive tax planning.

X represents that Trust 2 has received schedule K-1’s since Date 4 and X further
represents that all income has been reported on all affected returns of X and all of its
shareholders consistent with the treatment of X as an S corporation and that neither X
nor any of its shareholders intended to terminate X’s Subchapter S election. In addition,
X represents that Trust 2 has qualified as a QSST under § 1361(d) at all times since
Trust 2 acquired the X stock on Date 4, and other than the inadvertent failure to timely
file a valid QSST election for Trust 2, X has qualified as a small business corporation at
all times since its election on Date 2. Further, as of Date 4, B has filed consistent with
the treatment of Trust 2 as a QSST. Lastly, X and its shareholders agree to make any
adjustments required as a condition of obtaining relief under the inadvertent termination
rule as provided under § 1362(f) of the Code that may be required by the Secretary.

LAW AND ANALYSIS

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) defines a “small business corporation” as 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
PLR-139132-14                                    3

individual, (C) have a nonresident alien as a shareholder, and (D) have more than 1
class of stock.

Section 1361(d)(1) provides that a QSST whose beneficiary makes an election under
§ 1362(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the QSST’s
beneficiary will be treated as the owner (for purposes of § 678(a)) of that portion of the
QSST’s S corporation stock to which the election under § 1361(d)(2) applies. Under
§ 1361(d)(2)(A), a beneficiary of a QSST may elect to have § 1361(d) apply. Under
§ 1361(d)(2)(D), this election will be effective up to 15 days and two months before the
date of the election.

Section 1361(d)(3) provides that for purposes of § 1361(d), the term “qualified
subchapter S trust” means a trust (A) the terms of which require that – (i) during the life
of the current income beneficiary, there shall be only 1 income beneficiary of the trust;
(ii) any corpus distributed during the life of the current 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 such 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 1 individual who is a citizen or resident of the United States.

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 by signing and filing with the
service center with which the corporation files its income tax the applicable form or a
statement including the information listed in § 1.1361-1(j)(6)(ii).

Section 1.1361-1(j)(6)(iii)(A) provides that if S corporation stock is transferred to a trust,
the QSST election must be made within the 16-day-and-2-month period beginning on
the day that the stock is transferred to the trust.

Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (d)(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 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 the 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.
PLR-139132-14                                 4

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the failure to file a valid QSST election for Trust 2 caused a termination of X’s S
corporation election and that the S corporation election therefore terminated on Date 4.
We further conclude that the termination of X’s S election on Date 4 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 upon above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation or Trust 2’s eligibility as a QSST.

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3),
this ruling may not be used or cited as precedent.

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to your authorized representative.


                                       Sincerely,


                                       Faith Colson
                                       Faith Colson
                                       Senior Counsel, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)


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



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