Missed QSST election causes only inadvertent S termination

Plain-English summary

Stock in an S corporation passed under a will to a trust that was an eligible shareholder for two years. After that period, the trust became ineligible because its beneficiary had not filed the election to treat it as a qualified subchapter S trust, even though the trust otherwise met the QSST requirements. The corporation and trust were unaware of the filing requirement, did not intend to terminate S status, and represented that tax avoidance was not a motive. The IRS treated the termination as inadvertent under section 1362(f), so the corporation would continue to be treated as an S corporation. Relief required consistent S corporation and QSST reporting and filing the QSST election, effective on the termination date, within 120 days.

Ruling snapshot

• Question: Was the S corporation termination caused by the missed QSST election inadvertent under section 1362(f)?
• Outcome: approved; continuous S corporation treatment was granted subject to corrective filing
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201702014
Third Party Communication: None
Release Date: 1/13/2017
Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.01-02,
1362.02-00, 1362.02-02,
Person To Contact:
1362.04-00, 1362.00-00
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ID No. ----------------
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Telephone Number:
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Refer Reply To:
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CC:PSI:B01
PLR-114281-16
Date:
September 20, 2016

LEGEND

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

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

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

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

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

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

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

This responds to a letter dated April 20, 2016, and subsequent correspondence, submitted on behalf of X by X's authorized representative, requesting relief under § 1362(f) of the Internal Revenue Code (the Code).

FACTS
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According to the information submitted, X was incorporated under the laws of State and it began operations on Date 1. X elected to be treated as an S corporation effective Date 1. On Date 2, stock in X was transferred to Trust pursuant to the terms of the will of a deceased shareholder. Trust qualified as a permissible S corporation shareholder under § 1361(c)(2)(A)(iii) for the two-year period beginning on Date 2.

On Date 3, Trust became an ineligible shareholder of X. As a result, X's election to be an S corporation terminated. X represents that Trust has, at all times since the transfer of X stock to Trust, met the requirements of a qualified subchapter S trust (QSST), within the meaning of § 1361(d)(3). However, the beneficiary of Trust failed to timely file an election under § 1361(d)(2) for Trust to be a QSST.

X represents that X and Trust were unaware of the need to file a QSST election in order for Trust to continue to qualify as an eligible S corporation shareholder beginning on Date 3. X further represents that it did not intend for its S corporation election to terminate and the termination was not motivated by tax avoidance. X also represents that other than the failure to timely file a QSST election for Trust, X has qualified as a small business corporation at all times since its election on Date 1. Finally, X and its shareholders agree to make any adjustments required by the Secretary consistent with the treatment of X 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) defines a “small business corporation” as a domestic corporation that is not an ineligible corporation and that 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 a trust, all of which is treated (under subpart E of part I of subchapter J of chapter 1) as owned by an individual who is a citizen or resident of the United States, may be an S corporation shareholder.

Section 1361(c)(2)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust with respect to stock transferred to it pursuant to the terms of a will is a permitted shareholder, but only for the 2-year period beginning on the day on which such stock is transferred to it.
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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 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.

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(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever the 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 paragraph (2) or (3) of § 1362(d), (2) the Secretary determines that the circumstances resulting in such termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in termination, steps were taken so that the corporation is once more 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 any adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the circumstances resulting in the termination, the corporation will be treated as continuing to be an S corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the information submitted and the representations made, we conclude that X's S election terminated on Date 3 when Trust became an ineligible S corporation shareholder, and that the termination was inadvertent within the meaning of § 1362(f). Therefore, X will be treated as continuing to be an S corporation from Date 3, and thereafter, provided that X's S corporation election was otherwise valid and was not otherwise terminated under § 1362(d).

This ruling is contingent upon X and all of its shareholders treating X as having been an S corporation, and Trust as having been a QSST, for the period beginning Date 3, and thereafter. Within 120 days from the date of this letter, the beneficiary of Trust
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must file an election to treat Trust as a QSST, effective Date 3, with the appropriate service center. A copy of this letter should be attached to the election. If these conditions are not met, then this ruling is null and void.

Accordingly, X's shareholders, in determining their respective income tax liabilities, must include their pro rata share of the separately and non-separately computed items of X as provided in § 1366, make any adjustments to stock basis as provided in § 1367, and take into account distributions made by X as provided by § 1368.

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 concerning whether X is otherwise eligible to be treated as an S corporation, or whether Trust is eligible to be treated 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 P. Colson
Faith P. 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 § 6110 purposes