S corporation receives relief after QSST income was not distributed

Plain-English summary

Shareholders transferred S-corporation stock to seven trusts whose beneficiaries elected qualified subchapter S trust treatment. The trust instruments did not require current distribution of all income, and the trustees failed to distribute all income for two years, terminating the corporation's S election. The trustees later distributed each trust's income, and the corporation and shareholders agreed to make any required tax adjustments. The IRS found the termination inadvertent under IRC § 1362(f) and allowed the corporation to be treated as continuously maintaining its S election, assuming the election was otherwise valid.

Ruling snapshot

• Question: Was the S election's termination caused by the trusts' failure to distribute income inadvertent?
• Outcome: Approved, continuous S-corporation treatment granted
• Key authorities: IRC §§ 1361(d) and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201634019 Third Party Communication: None
Release Date: 8/19/2016 Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.03-02
Person To Contact:
-------------------------------------------------- ----------------, ID No. ------------------
------------------------ Telephone Number:
-------------------------------------------- ----------------------
------------------------------------------ Refer Reply To:
CC:PSI:B01
PLR-138576-15
Date:
May 19, 2016

LEGEND

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

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

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

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

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

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

Trust 4 = ---------------------------------

Trust 5 = -------------------------------------

Trust 6 = ------------------------------

Trust 7 = -------------------------------

PLR-138576-15 2

D1 = ------------------------

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

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

D4 = ----------------------

Year 1 = -------

Year 2 = -------

State = ---------

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

This responds to a letter dated November 16, 2015, and subsequent information,
submitted on behalf of X by X’s authorized representative, requesting relief under
§ 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted, X was incorporated on D1, under the laws of
State. Effective D2, X elected to be taxed as an S corporation.

On D3, A and B, shareholders of X, each transferred shares of X to Trust 1, Trust 2,
Trust 3, Trust 4, Trust 5, Trust 6, and Trust 7 (hereinafter referred to as the Trusts). The
beneficiaries of the Trusts each made a timely election pursuant to § 1361(d)(2) to treat
each Trust as a qualified subchapter S trust (QSST). None of the trust instruments
require that all of the income be distributed currently and the trustees of the Trusts failed
to distribute all of the income to the beneficiaries of the Trusts for Year 1 and Year 2,
thereby causing X’s S election to terminate effective D4.

X represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent. X further represents that the trustees have corrected this
error and have distributed each Trust’s income to the respective beneficiary. X also
represents that X and its shareholders have filed their income tax returns consistent
with having a valid S election in effect since D2 and have treated the Trusts as QSSTs
since D3. 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.

PLR-138576-15 3

LAW AND ANALYSIS

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

Section 1361(c)(2)(A)(i) provides that, for purposes of § 1361(b)(1), a trust all of which
is treated (under subpart E of part I of subchapter J of this chapter) 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 qualified subchapter S trust with
respect to which a beneficiary makes an election under § 1361(d)(2), such trust shall be
treated as a trust described in § 1361(c)(2)(A)(i) and 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 §
1362(d)(2) is made.

Section 1361(d)(3) defines the term “qualified subchapter S trust” as a trust all of the
income (within the meaning of § 643(b)) of which is distributed (or required to be
distributed) currently to one individual who is a citizen or resident of the United States.
In addition, the terms of the trust must require that (i) during the lifetime of the current
income beneficiary, there shall be only one income beneficiary of the trust, (ii) any
corpus distributed during the life of the current income 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 such beneficiary.

Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d), (2) the Secretary determines that the
circumstances resulting in the termination were inadvertent, (3) no later than a
reasonable period of time after the 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 such corporation at any time
during the period of inadvertent termination of the S election, 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 termination, the corporation is treated as an S corporation
during the period specified by the Secretary.

PLR-138576-15 4

CONCLUSION

Based solely on the facts submitted and representations made, we conclude X’s S
election terminated on D4 because the trustees of the Trusts failed to distribute the
income of the Trusts to each Trust’s respective beneficiary. We also conclude that the
termination of X’s S 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
D4 and thereafter, provided that X’s S election is valid and not otherwise terminated
under § 1362(d).

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed or implied concerning the eligibility of X
as an S corporation or the Trusts as QSSTs.

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 the power of attorney on file with this office, a copy of this letter is
being sent to the taxpayer’s authorized representative.

Sincerely,

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

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

cc: