Late S election and QSST relief approved

Plain-English summary

An S corporation parent distributed all stock of its qualified subchapter S subsidiary to three trusts, ending the subsidiary election. The company intended to become an S corporation immediately, but Form 2553 was not filed, and the trusts were ineligible shareholders because their beneficiaries had not made qualified subchapter S trust elections and the trusts had not distributed all income. The IRS granted 120 days for the company to file its S election and for the beneficiaries to file QSST elections effective on the distribution date. Subject to those filings and continued eligibility, the company would be treated as an S corporation and the trusts as QSSTs from that date forward.

Ruling snapshot

• Question: May the company and trust beneficiaries make late S corporation and QSST elections after the QSub termination?
• Outcome: approved
• Key authorities: IRC §§ 1361(b)(3), 1361(d), 1362(b)(5), 1362(f); Treas. Reg. § 1.1361-5

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201651001 Third Party Communication: None
Release Date: 12/16/2016 Date of Communication: Not Applicable
Index Number: 1362.04-00, 9100.31-00
Person To Contact:
------------------------------------------- -----------------------------, ID No. -------------
----------------------------- -----------------
------------------------ Telephone Number:
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Refer Reply To:
CC:PSI:01
PLR-107617-16
Date:
August 31, 2016

Legend
Company = ---------------------------------------------------------------------------------------------
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Parent = ---------------------------------------------------
Trust1 = ---------------------------------------------------------------------------------------------
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Trust2 = ---------------------------------------------------------------------------------------------
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Trust3 = ---------------------------------------------------------------------------------------------
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State = --------------
Date 1 = -------------------
Date 2 = -------------------
Date 3 = -----------------
Date 4 = ---------------------------------------------------------------------------------------------
Year = -------------

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

   This letter responds to a letter received by our office, dated February 16, 2016,

submitted on behalf of Company by its authorized representatives, requesting rulings
related to its S elections under §§ 1361 (b)(5) and 1362(f) of the Internal Revenue
Code.

                                                FACTS

   Company represents that it was incorporated on Date 1 under the laws of State.

Parent, an S corporation, owned 100% of the stock of Company. Parent made an
election to treat Company as a Qualified Subchapter S Subsidiary (QSub) effective Date
PLR-107617-16 2

2. As of Date 3, Parent distributed its stock in Company to Parent’s shareholders Trust
   1, Trust 2, and Trust 3. Company intended to elect to be an S corporation effective
   Date 3 but the proper election was not filed.

   Trust1, Trust 2, and Trust 3 were also ineligible S corporation shareholders.
   

   Company represents that Trust 1, Trust 2, and Trust 3 met the qualified subchapter S
   trust (QSST) trust requirements described in § 1361(d)(3) as of Date 3 and thereafter
   except that Trust1 , Trust 2, and Trust3 failed to distribute all of their income to their
   beneficiaries for Year. Further, none of the income beneficiaries timely filed QSST
   elections.

   On Date 4, Company filed a certificate of dissolution with State.

   Company and its shareholders represent that they intended Company be an S
   corporation immediately after the termination of the QSub election. Company
   represents that Company and its shareholders have filed their federal income tax
   returns consistent with having a valid S corporation election in effect for Company.
   Company and its shareholders have agreed to make such adjustments (consistent with
   the treatment of Company as an S corporation) as may be required by the Secretary.

                             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) 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)(3), 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(b)(3)(A) provides that, except as provided in regulations prescribed
   by the Secretary, for purposes of the Code — (i) a corporation which is a QSub shall not
   be treated as a separate corporation, and (ii) all assets, liabilities, and items of income,
   deduction, and credit of a QSub shall be treated as assets, liabilities, and such items (as
   the case may be) of the S corporation.

   Section 1361(b)(3)(B) provides that, for purposes of § 1361(b)(3), the term
   

   “qualified subchapter S subsidiary” means any domestic corporation which is not an
   ineligible corporation (as defined in § 1361(b)(2)), if — (i) 100 percent of the stock of
   such corporation is held by the S corporation, and (ii) the S corporation elects to treat
   such corporation as a QSub.
   PLR-107617-16 3

   Section 1361(b)(3)(D) provides, in part, that if a corporation's status as a QSub
   

   terminates, such corporation (and any successor corporation) shall not be eligible to
   make an election under § 1362(a) to be treated as an S corporation before its 5th
   taxable year which begins after the 1st taxable year for which such termination was
   effective, unless the Secretary consents to such election.

   Section 1.1361-5(a)(1)(iii) of the Income Tax Regulations provides that a QSub
   election will terminate at the close of the day on which an event occurs that renders the
   subsidiary ineligible for QSub status under § 1361(b)(3)(B).

   Section 1.1361-5(c)(2) provides that in the case of S and QSub elections
   

   effective after December 31, 1996, if a corporation's QSub election terminates, the
   corporation may, without requesting the Commissioner's consent, make an S election
   before the expiration of the five-year period described in § 1361(b)(3)(D) if immediately
   following the termination, the corporation (or its successor corporation) is otherwise
   eligible to make an S election and the relevant election is made effective immediately
   following the termination of the QSub election.

   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(b)(1) provides that an election under § 1362(a) may be made by a
   

   small business corporation for any taxable year - (A) at any time during the preceding
   taxable year, or (B) at any time during the taxable year and on or before the 15th day of
   the third month of the taxable year.

   Section 1362(b)(5) provides that if (A) an election under § 1362(a) is made for
   

   any taxable year (determined without regard to § 1362(b)(3)), after the date prescribed
   by § 1362(b) for making such election for such taxable year or no such election is made
   for any taxable year, and (B) the Secretary determines that there was reasonable cause
   for the failure to timely make the election, the Secretary may treat such an election as
   timely made for the taxable year (and § 1362(b)(3) shall not apply).

   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 § 1362(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.
   PLR-107617-16 4

   Section 1361(d)(3) defines a QSST as 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 income
   beneficiary may be distributed only to such beneficiary; (iii) the income interest of the
   current beneficiary in the trust shall terminate on the earlier of the 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 (with 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 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
   

   corporation 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), (2)
   the Secretary determines that the circumstances resulting in such ineffectiveness were
   inadvertent, (3) no later than a reasonable period of time after discovery of the
   circumstances resulting in such ineffectiveness, steps were taken so that the
   corporation for which the election was made is a small business corporation, and (4) the
   corporation for which the election was made, and each person who was a shareholder
   in the corporation at any time during the period specified pursuant to § 1362(f), agrees
   to make 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 such ineffectiveness, the corporation
   shall be treated as an S corporation during the period specified by the Secretary.

                                  CONCLUSION
   
   Based on the facts submitted and representations made, Company has
   

   established reasonable cause for failing to make a timely S corporation election. Thus,
   we conclude that Company is eligible for relief under § 1362(b)(5). Accordingly, if
   Company makes an election to be an S corporation by filing with the appropriate service
   center a completed Form 2553 effective Date 3, within 120 days following the date of
   this letter, the election shall be treated as timely made. A copy of this letter should be
   attached to the Form 2553 filed with the service center. A copy is enclosed for that
   purpose.

   Company failed to timely file an election to be treated as an S corporation
   

   effective Date 3. Had Company timely filed the election it would have been ineffective
   because Company had ineligible shareholders on Date 3. Based solely on the facts
   submitted and representations made, we conclude that Company’s election to be
   treated as an S corporation effective Date 3, would have been ineffective and also
   conclude that the ineffectiveness would have been in advertent within the meaning of
   § 1362(f).
   PLR-107617-16 5

   Under the provisions of § 1362(f), Company will be treated as an S corporation
   and Trust 1, Trust 2, Trust3 will be treated as QSSTs effective Date 3 and thereafter.
   This conclusion is reached provided that Company’s S corporation election is otherwise
   valid and was not otherwise terminated and Trust1, Trust2 and Trust3’s QSST elections
   are otherwise valid and not terminated.

   This ruling is conditioned on the income beneficiaries of Trust1, Trust2, and
   

   Trust3 filing QSST elections effective Date 3 with the appropriate service center. The
   QSST elections must be filed within 120 days following the date of this letter and a copy
   of this letter should be attached to any such elections or returns. If Company , Trust1,
   Trust2, Trust3, and their beneficiaries fail to treat themselves as described above, this
   ruling is null and void.

   Except as expressly provided herein, we express or imply no opinion concerning
   

   the tax consequences of any aspect of any transaction or item discussed or referenced
   in this letter. Specifically, we express or imply no opinion regarding whether Company is
   otherwise eligible to be an S corporation or whether Company was a valid QSub.

   This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the
   

   Code provides that it may not be used or cited as precedent. The ruling contained in
   this letter is 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 ruling request,
   it is subject to verification on examination.

   In accordance with the power of attorney on file with this office, we are sending a
   copy of this letter to Company's authorized representatives.

                                  Sincerely,
   
                                  Faith P. Colson
                                  Faith P. Colson
                                  Senior Counsel, Branch 1
                                  (Passthroughs & Special Industries)
   

Enclosures (2)
Copy of Letter
Copy for 6110 purposes