Missing QSST election receives inadvertent termination relief

Plain-English summary

A trust held S corporation stock and was a grantor trust until its owner died. Within two years, the trust was reformed to have one current income beneficiary and became eligible to elect qualified subchapter S trust status. The beneficiary did not file the QSST election, causing the corporation's S election to terminate when the trust became an ineligible shareholder. The IRS found the termination inadvertent and allowed the corporation to continue S treatment from the termination date. The relief required the income beneficiary to file a QSST election effective on that date within 120 days.

Ruling snapshot

• Question: Could the corporation preserve S status after a trust beneficiary failed to file a QSST election?
• Outcome: Approved, conditioned on filing the QSST election within 120 days.
• Key authorities: IRC §§ 1361(c) and (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: 201636014                                                Third Party Communication: None
Release Date: 9/2/2016                                           Date of Communication: Not Applicable
Index Numbers: 1362.04-00
                                                                 Person To Contact:
---------------------------------------------                    -------------------------, ID No. -----------------
-----------------------------------------------                  ----------------------------------------------------
-------------------------------                                  Telephone Number:
 ------------------------------------------                      --------------------
                                                                 Refer Reply To:
                                                                 CC:PSI:B03
                                                                 PLR-108401-16
                                                                 Date:
                                                                 June 02, 2016

Legend

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

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

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

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

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

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

D5                              =           -----------------

Trust                           =           ------------------------------------------------------------------------
                                            -------------------------------

Income Beneficiary              =           ------------------------------------------------------------------------
                                            ---------------------------------------------------


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

       This letter responds to a letter dated March 4, 2016, and subsequent
correspondence submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code (Code).
PLR-108401-16                                2


                                         FACTS

        The information submitted states that X was organized under the laws of State
on D1 and elected to be an S corporation effective D2. Trust was a grantor trust until
D3, when Trust’s owner died. On D4 (within two years of D3), the terms of Trust were
reformed so that Trust had only one current income beneficiary, Income Beneficiary,
and was therefore eligible to make an election to be treated as a qualified subchapter S
trust (QSST). However, Income Beneficiary failed to file a QSST election. Therefore,
on D5, X’s S corporation election terminated.

       X represents that the termination was not motivated by tax avoidance or
retroactive tax planning. X further represents that it has filed consistently as an S
corporation since D2. X and its shareholder have agreed to make any adjustments that
the Commissioner may require, consistent with the treatment of X as an S corporation.

                                  LAW AND ANALYSIS

      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 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) provides that the term “small business corporation” means 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 one class of stock.

       Section 1361(c)(2)(A)(i) provides that for purposes of § 1361(b)(1)(B), a trust all
of which is treated (under subpart E of part 1 of subchapter J of Chapter 1) as owned by
an individual who is a citizen or resident of the United States may be a shareholder.

       Section 1361(d)(1) provides that a QSST whose beneficiary makes an election
under § 1361(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the
beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) 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.
PLR-108401-16                                 3

       Section 1361(d)(2)(A) provides that a beneficiary of a QSST (or his legal
representative) may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that
an election under § 1361(d)(2) shall be effective up to 15 days and 2 months before the
date of the election.

        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 where the corporation files its income tax return the
applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

       Section 1362(d)(2)(A) provides that an election under § 1362(a) will 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. Section 1362(d)(2)(B) provides that any termination under
§ 1362(d)(2)(A) is effective on and after the date of cessation.

        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 (3), (2) the Secretary
determines that the circumstances resulting in the termination were inadvertent, (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
the termination, steps were taken (A) 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 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 termination, the corporation will be
treated as an S corporation during the period specified by the Secretary.

                                      CONCLUSION

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on D5 when X had an ineligible shareholder.
We also conclude that the circumstances resulting in the termination were inadvertent
within the meaning of § 1362(f). Accordingly, under § 1362(f), X will be treated as an S
corporation from D5 and thereafter, provided X’s S corporation election was otherwise
valid and has not otherwise terminated under § 1362(d) for reasons not addressed in
this letter.

        This ruling is conditioned on the Income Beneficiary filing a QSST election for
Trust, effective D5, with the appropriate service center within 120 days of the date of
this letter. A copy of this letter should be attached to the QSST election.

       Except as specifically ruled above, we express or imply no opinion concerning
the federal tax consequences of the facts described above under any other provisions
PLR-108401-16                                4

of the Code. Specifically, we express or imply no opinion regarding X’s eligibility to be
an S corporation under § 1361.


       This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
of the Code 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 X’s authorized representative.

                                          Sincerely,


                                          Bradford Poston
                                          Senior Counsel, Branch 3
                                          Office of the Associate Chief Counsel
                                          (Passthroughs and Special Industries)
Enclosures (2):

       Copy of this letter
       Copy for § 6110 purposes



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