S corporation received inadvertent termination relief for trust shares

Plain-English summary

An S corporation shareholder died, and the shareholder's stock passed to a trust for a minor beneficiary. The trust was intended to be a qualified subchapter S trust, but its terms did not qualify and the beneficiary's guardian did not timely file the required election. A state court later approved amendments designed to make the trust eligible. The IRS concluded that the corporation's S election had terminated when the ineligible trust acquired the shares, but that the termination was inadvertent under section 1362(f). The corporation could continue to be treated as an S corporation if the guardian filed a qualified subchapter S trust election effective on the court-approved amendment date within 120 days.

Ruling snapshot

• Question: Could an S corporation receive relief after stock passed to a nonqualifying trust and no timely qualified subchapter S trust election was filed?
• Outcome: Approved, conditioned on filing the trust election within 120 days.
• Key authorities: IRC §§ 643, 678, 1361, and 1362; Treas. Reg. § 1.1361-1(j)(6)(ii); Rev. Rul. 93-79.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201644007 Third Party Communication: None
Release Date: 10/28/2016 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.02-02,
1361.03-02 Person To Contact:
----------------, ID No. ------------------
-------------------------------------- Telephone Number:
---------------------------------- ----------------------
---------------------------------- Refer Reply To:
------------------------------------------------ CC:PSI:B01
PLR-103896-16
Date:
July 28, 2016

LEGEND

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

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

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

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

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

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

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

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

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

Court = ------------------------------------------

State = ---------------
PLR-103896-16 2

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

This responds to a letter signed December 14, 2015, and subsequent correspondence,
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 and elected to be taxed as an S corporation effective Date 2, under the laws
of State.

A, a shareholder of X, died on Date 3. A’s shares in X were transferred to Trust on Date
4 for the benefit of B, a minor. Trust was intended to be a qualified subchapter S trust
(QSST). However, the guardian of B failed to timely file a QSST election for Trust.
Further, Trust did not meet the requirements to be a QSST. Thus, X’s S corporation
election terminated on Date 4 when X stock was transferred to Trust, an ineligible
shareholder. On Date 5, Court of State filed an order approving amendments to Trust
to qualify Trust as a QSST.

X represents that the termination of X’s S election was inadvertent and was not
motivated by a tax avoidance motive or retroactive tax planning. Lastly, X represents
that X and its shareholders agree to make any adjustments consistent with treatment of
X as an S corporation as 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
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
PLR-103896-16 3

§ 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 one 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 one 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 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, in relevant part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2); (2) the Secretary determines that the
circumstances resulting in 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
ineffectiveness or termination, such corporation shall be treated as an S corporation
during the period specified by the Secretary.

Rev. Rul. 93-79, 1993-2 C.B. 269, provides that a state court order that reforms a trust
to meet the requirements of QSST is recognized prospectively.

CONCLUSION
PLR-103896-16 4

Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on Date 4 when stock was transferred to Trust, an
ineligible shareholder. We further conclude that the termination of X’s S election on
Date 4 was inadvertent within the meaning of § 1362(f). Pursuant to the provisions of
§ 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 the guardian of B, the current income beneficiary of Trust,
filing a QSST election for Trust effective Date 5 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’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

cc: