Corporation preserves S status after missed trust elections

Plain-English summary

Three trusts acquired S corporation shares but their beneficiaries did not file qualified subchapter S trust elections, and a fourth trust did not file its electing small business trust election. Some of the trusts also failed in a later year to distribute all income as defined under the trust accounting rules, although they distributed all taxable income. The corporation and its shareholders consistently reported as if the S corporation and trust elections remained effective. The IRS treated the resulting termination as inadvertent and allowed continuous S corporation status from the date the trusts acquired their shares. Relief requires the three beneficiaries to file QSST elections and the fourth trust's trustee to file an ESBT election within 120 days. The corporation and all shareholders must continue consistent S corporation reporting, or the ruling becomes void.

Ruling snapshot

• Question: Could the corporation retain S status despite missed QSST and ESBT elections and a trust-income distribution failure?
• Outcome: approved, subject to corrective trust elections within 120 days and consistent S corporation reporting
• Key authorities: IRC §§ 643(b), 1361(d) and (e), 1362(f), and 1366 through 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201714007 Third Party Communication: None
Release Date: 4/7/2017 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
-------------------- ---------------------, ID No. ------------------
------------------------------------- Telephone Number:
------------------------------------ ----------------------
---------------------------------------- Refer Reply To:
---------------------------------------------- CC:PSI:B01
PLR-119481-16
Date:
December 09, 2016

Legend

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

Trust A = -----------------------------------

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Trust B = -----------------------------------

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Trust C = -----------------------------------

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Trust D = -------------------------------------------

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

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

PLR-119481-16 2

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

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

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

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

  This responds to a letter dated April 28, 2016, and subsequent correspondence,

submitted on behalf of X, requesting relief from the inadvertent termination of its S
corporation election pursuant to § 1362(f) of the Internal Revenue Code.

Facts

   Based on the information submitted and representations made therein, we

understand the relevant facts to be as follows. X was incorporated under the laws of
State on Date 1, and elected to be treated as an S corporation effective Date 2.

    X represents that Trust A, Trust B, and Trust C were eligible to file elections

pursuant to § 1361(d)(2) to be treated as qualified subchapter S trusts (QSSTs). On
Date 3, Trust A, Trust B, and Trust C acquired shares of X stock. Nevertheless, no
election was made to treat Trust A, Trust B, or Trust C as a QSST. X represents that
the income beneficiaries of Trust A, Trust B, and Trust C each reported the beneficiary’s
distributable share of X’s items of income, loss, deductions, and credits, if any, as if
Trust A, Trust B, and Trust C each had a valid QSST election in effect.

    On Date 3, Trust D also acquired shares of X stock. X represents that Trust D

was eligible to file an election pursuant to § 1361(e)(3) to be treated as an electing small
business trust (ESBT). Nevertheless, Trust D did not elect to be treated as an ESBT
effective Date 3. Trust D reported its share of X’s items of income, loss, deductions,
and credits, if any, as if Trust D had a valid ESBT election in effect.

     In Year 1, each of Trust 1, Trust 2, and Trust 3 distributed all of its income as

defined in § 643(b). In Year 2, each of Trust 1, Trust 2, and Trust 3 did not distribute all
of its income as defined in § 643(b). Nevertheless, X represents that each of those
trusts did distribute all of its taxable income for Year 2.

PLR-119481-16 3

   In Year 3, all of the shares of X held by Trust 3 were distributed to Trust 1 and

Trust 2. In Year 4, all of the current and accumulated income, within the meaning of
§ 643(b), of Trust 1 and Trust 2 was distributed to their respective beneficiaries.

   X represents that X and its shareholders have reported their income consistently

with X being an S corporation. X represents that the circumstances resulting in the
termination of X’s S corporation election were inadvertent and were not motivated by tax
avoidance or retroactive tax planning. In addition, X and all of its shareholders agree to
make any adjustments consistent with the treatment of X as an S corporation as may be
required by the Secretary with respect to the period specified by § 1362(f).

Law

  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)(B) provides that, for purposes of subchapter S, the term

"small business corporation" means a domestic corporation which is not an ineligible
corporation and which does not 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(c)(2)(A)(i) provides that, for the purposes of § 1362(b)(1)(B), a

trust, all of which is treated (under title 26, subtitle A, chapter 1, subchapter J, part I,
subpart E of the United States Code) 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)(v) provides that, for the purposes of § 1362(b)(1)(B), an

ESBT may be an S corporation shareholder.

   Section 1361(d)(1) provides that, in the case of a QSST with respect to which a

beneficiary makes an election under § 1361(c)(2), (A) such trust will be treated as a
trust described in § 1361(c)(2)(A)(i), and (B) 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)(3)(A) provides that a QSST is a trust, the terms of which require

that (i) during the life of the current income beneficiary, there shall be only 1 income

PLR-119481-16 4

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 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 such
beneficiary. In addition, § 1361(d)(3)(B) requires that the trust distribute (or require to
be distributed) all of its income (within the meaning of § 643(b)) currently to 1 individual
who is a citizen or resident of the United States.

   Section 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except

as provided in § 1362(e)(2)(B), an ESBT means any trust if (i) such trust does not have
as a beneficiary any person other than (I) an individual, (II) an estate, (III) an
organization described in § 170(c)(2), (3), (4), or (5), or (IV) an organization described in
§ 170(c)(1) which holds a contingent interest in such trust and is not a potential current
beneficiary, (ii) no interest in such trust was acquired by purchase, and (iii) an election
under § 1361(e) applies to such trust.

    Section 1361(e)(1)(B) provides that the term “electing small business trust” shall

not include (i) any qualified subchapter S trust (as defined in § 1361(d)(3)) if an election
under § 1361(d)(2) applies to any corporation the stock of which is held by such trust,
(ii) any trust exempt from tax under subtitle A, and (iii) any charitable remainder annuity
trust or charitable remainder unitrust (as defined in § 664(d)).

   Section 1361(e)(3) provides that an election under § 1361(e) shall be made by

the trustee. Any such election shall apply to the taxable year of the trust for which made
and all subsequent taxable years of such trust unless revoked with the consent of the
Secretary.

    Section 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current

income beneficiary of a QSST must make the election under § 1361(d)(2) by signing
and filing with the service center with which the corporation files its income tax returns
the applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

   Section 1.1361-1(j)(6)(iii) provides in part that, if S corporation stock is

transferred to a trust, the QSST election must be made within the 16-day-and-2-month
period beginning on the day that the stock is transferred to the trust.

   Section 1.1361-1(j)(7)(i) provides that the income beneficiary who makes the

QSST election and is treated (for purposes of § 678(a)) as the owner of that portion of
the trust that consists of S corporation stock is treated as the shareholder for purposes
of §§ 1361(b)(1), 1366, 1367, and 1368.

PLR-119481-16 5

    Section 1.1361-1(m)(2)(i) provides that the trustee of an ESBT must make the

ESBT election by signing and filing, with the service center where the S corporation files
its income tax return, a statement that meets the requirements of § 1.1361-1(m)(2)(ii).

   Section 1.1361-1(m)(2)(iii) provides that the trustee of an ESBT must file the

ESBT election within the time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a
QSST election (generally within the 16-day-and-2-month period beginning on the day
that the stock is transferred to the trust).

  Section 1362(d)(2) provides that an election under § 1362(a) shall 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. The termination is effective on and after the day of the termination.

   Section 1362(f) provides, in part, that if -- (1) an election under § 1362(a) by any

corporation (A) 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 (B) was terminated under § 1362(d)(2);
(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 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 in such corporation at any time
during the period specified pursuant to § 1362(f), agrees to make such 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.

Conclusion

    Based solely on the information submitted and the representations made, we

conclude that X's S corporation election was terminated as of Date 3 because X had an
ineligible shareholder, and would have been terminated as a result of the failure to
distribute income within the meaning of § 643(b). We further conclude that the
termination of X’s S corporation election constituted an inadvertent termination within
the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be
treated as continuing to be an S corporation from Date 3 and thereafter, provided that,
apart from the missed ESBT and QSST elections and the failure to distribute income as
defined in § 643(b) discussed herein, X's S corporation election was otherwise valid and
has not otherwise terminated under § 1362(d).

PLR-119481-16 6

    This ruling is contingent on X and all of its shareholders treating X as having

been an S corporation for the period beginning Date 3, and thereafter. Accordingly, in
determining their respective income tax, all the shareholders of X must include their pro-
rata share of the separately stated items of income (including tax-exempt income), loss,
deduction, or credit and nonseparately computed items of income and loss of X as
provided in § 1366, make adjustments to basis as provided in § 1367, and take into
account any distributions made by X as provided in § 1368. If X or its shareholders fail
to treat themselves as described above, this ruling is null and void.

   This ruling is contingent on the beneficiaries of Trust A, Trust B, and Trust C

each making a valid QSST election, effective Date 3, with the appropriate service center
within 120 days of the date of this letter. This ruling is also contingent on the trustee of
Trust D making a valid ESBT 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 of these trusts' QSST or ESBT elections.

    Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the transactions described above under any other
provision of the Code. Specifically, we express or imply no opinion regarding whether X
is otherwise eligible to be an S corporation, whether Trust A, Trust B, and Trust C are
eligible QSSTs under § 1361(d), and whether Trust D is an eligible ESBT under
§ 1361(e).

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

provides that it may not be used or cited as precedent.

   In accordance with a power of attorney on file with this office, a copy of this letter

is being sent to X's authorized representatives.

                                   Sincerely,



                                   David R. Haglund
                                   David R. Haglund
                                   Chief, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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