Late QSST elections do not end S corporation status

Plain-English summary

Two shareholders transferred S corporation stock to six trusts that represented they qualified as qualified subchapter S trusts, but no beneficiary made a timely QSST election. The missing elections caused the corporation's S election to terminate when the first transfers occurred. The corporation and shareholders consistently reported the business as an S corporation and represented that the failure did not involve tax avoidance or retroactive tax planning. The IRS found the termination inadvertent and allowed S corporation treatment to continue from the transfer date. The relief required each trust's beneficiary or representative to file a QSST election effective on that date within 120 days.

Ruling snapshot

• Question: Could the corporation preserve S status after six trusts failed to make timely QSST elections?
• Outcome: Approved, conditioned on filing all six QSST elections within 120 days.
• Key authorities: IRC §§ 1361(d) and 1362(d) and (f); Treas. Reg. § 1.1362-4(b).

Full text (IRS public release)

Internal Revenue Service                                  Department of the Treasury
                                                          Washington, DC 20224

Number: 201636015                                         Third Party Communication: None
Release Date: 9/2/2016                                    Date of Communication: Not Applicable
Index Numbers:1362.01-00, 1362.04-00
                                                          Person To Contact:
                                                          ---------------------, ID No. ----------------
-----------------------------------------                 Telephone Number:
---------------------------------------------             ------------------
------------------------                                  Refer Reply To:
----------------------------                              CC:PSI:B3
                                                          PLR-109776-16
                                                          Date:
                                                          May 31, 2016




                                                    Legend

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

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

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

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

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

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

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

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

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

State     = ---------------------
PLR-109776-16                                  2

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

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

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

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

Date 5 = --------------------------


Dear -------------------

        This letter responds to a letter dated March 21, 2016, submitted on behalf of X by
its authorized representatives, requesting a ruling under § 1362(f) of the Internal
Revenue Code (Code).

                                            Facts

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

        On Date 3, A transferred shares of X to Trust 1, Trust 2, and Trust 3. Also, on
Date 3, B transferred shares of X to Trust 4, Trust 5, and Trust 6. In addition, on Date 4
and Date 5, A transferred shares of X to Trust 4, Trust 5, and Trust 6. X represents that
Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 qualified as qualified subchapter S
trusts (“QSSTs”) under section 1361(d) from Date 3. However, no QSST election was
made for any of the trusts.

        X represents that there was no tax avoidance or retroactive tax planning involved
in the failure of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, or Trust 6 to timely elect to be
classified as QSSTs. In addition, X and its shareholders agree to make any
adjustments consistent with the treatment of X as an S corporation as may be required
by the Secretary. X also represents that X and all its shareholders have filed
consistently with X being treated as an S corporation.

                                      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 the term “small business corporation” means
a domestic corporation that is not an ineligible corporation and that does not, among
PLR-109776-16                                3

other requirements, 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(d)(1) provides that in the case of a QSST with respect to which a
beneficiary makes an election under § 1361(d)(2), the trust is 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 § 1361(d)(2) is made. Section
1361(d)(2)(A) provides that a beneficiary of a QSST may elect to have § 1361(d)(1)
apply.

      Section 1362(a)(1) 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) is 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 that if (1) an election under § 1362(a) or
§ 1361(b)(3)(B)(ii) by any corporation (i) was not effective for the taxable year for which
made (determined without regard to § 1362(b)(2)) by reason of a failure to meet the
requirements of § 1361(b) or to obtain shareholder consents, or (ii) was terminated
under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (2) the Secretary determines that the
circumstances resulting in such ineffectiveness or termination were inadvertent; (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
such ineffectiveness or termination, steps were taken so that the corporation for which
the election was made or the termination occurred is a small business corporation or a
QSub, as the case may be, or to acquire the required shareholder consents; and (4) the
corporation for which the election was made or the termination occurred, and each
person who was a shareholder of the corporation at any time during the period specified
pursuant to § 1362(f), agree to make the adjustments (consistent with the treatment of
the corporation as an S corporation or a QSub, as the case may be) as may be required
by the Secretary with respect to this period, then, notwithstanding the circumstances
resulting in such ineffectiveness or termination, the corporation shall be treated as an S
corporation or a QSub, as the case may be, during the period specified by the
Secretary.

       Section 1.1362-4(b) provides that the determination of whether a termination was
inadvertent is made by the Commissioner. The corporation has the burden of
establishing that under the relevant facts and circumstances the Commissioner should
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determine that the termination was inadvertent. The fact that the termination event was
not reasonably within the control of the corporation and was not part of a plan to
terminate the election, or the fact that the terminating event or circumstance took place
without the knowledge of the corporation, notwithstanding its due diligence to safeguard
itself against such an event or circumstance, tends to establish that the termination of
the election was inadvertent.

                                       Conclusion

       Based solely on the facts submitted and representations made, we conclude that
X’s S corporation election terminated on Date 3 when shares of X were transferred to
Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6, and that the termination was
inadvertent within the meaning of § 1362(f). We also conclude that if X’s S corporation
election had not already terminated, X’s S corporation election would have terminated
on Date 4 and Date 5 when A transferred shares of X stock to Trust 4, Trust 5, and
Trust 6. Consequently, we rule that X will be treated as an S corporation from Date 3
and thereafter provided that X’s S corporation election as otherwise valid and not
otherwise terminated under § 1362(d).

       This ruling is contingent on the beneficiary (or beneficiary’s representative) of
Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 filing a QSST election effective
Date 3 with the appropriate service center within 120 days of the date of this letter. A
copy of this letter should be attached to each 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 provision of
the Code, including whether X was otherwise a valid S corporation and whether Trust 1,
Trust 2, Trust 3, Trust 4, Trust 5, and Trust 6 are valid QSSTs.

       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 for precedent.
PLR-109776-16                                5


       Pursuant to a power of attorney on file, we are sending a copy of this letter to X’s
authorized representatives.

      The rulings contained in this letter are 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 rulings requested, it is subject to verification on
examination.



                                      Sincerely,



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




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


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