Missing trust elections do not end corporation's S status

Plain-English summary

Shares of an S corporation were transferred at different times to three trusts that were represented to qualify as qualified subchapter S trusts. The income beneficiaries did not timely file the required QSST elections, causing the corporation's S election to terminate upon the first transfer and creating additional potential termination events on the later transfers. The corporation and trusts consistently filed returns as though S corporation and QSST status continued, and the corporation represented that the failures were inadvertent and not motivated by tax avoidance. The IRS allowed continuous S corporation treatment from the first transfer. Relief requires each trust beneficiary to file a QSST election effective on the date that trust received its shares, with all elections due within 120 days.

Ruling snapshot

• Question: Could the corporation preserve S status despite missing QSST elections for three shareholder trusts?
• Outcome: approved, subject to filing all three QSST elections within 120 days
• Key authorities: IRC §§ 1361(d), 1362(d)(2), and 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201714011 Third Party Communication: None
Release Date: 4/7/2017 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
---------------------------------------------------------- ----------------------------, ID No. --------------
------------------------- ----------------
------------------- Telephone Number:
----------------------------- --------------------
Refer Reply To:
CC:PSI:01
PLR-121506-16
Date:
December 08, 2016

Legend
X = ------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
--------------------------------
Trust 1 = ------------------------------------------------------------------------------------------------
-------------------------------
Trust 2 = ------------------------------------------------------------------------------------------------
---------------------
Trust 3 = ------------------------------------------------------------------------------------------------
-------------------------------
State = ----------
Date 1 = -----------------------
Date 2 = --------------------------
Date 3 = ------------------
Date 4 = --------------------------
Date 5 = -----------------

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

  This responds to a letter dated July 5, 2015, and subsequent correspondence

submitted on behalf of X by X’s authorized representatives, requesting inadvertent
termination relief under § 1362(f) of the Internal Revenue Code.

                                                 FACTS

   The information submitted states that X was incorporated under the laws of State

on Date 1 and elected to be an S corporation effective Date 2. On Date 3 shares of X
were transferred to Trust 1. X represents that Trust 1 qualified to elect to be treated as
a qualified subchapter S trust (QSST), however, a timely QSST election within the

PLR-121506-16 2

meaning of § 1361(d)(2) was not filed, thereby, causing X’s S corporation election to
terminate on Date 3.

    On Date 4, shares of X were transferred to Trust 2. X represents that Trust 2

qualified to elect to be treated as a QSST; however, a timely QSST election within the
meaning of § 1361(d)(2) was not filed. The failure to make the QSST election would
have terminated X’s S corporation election had it not already been terminated.

    On Date 5, shares of X were transferred to Trust 3. X represents that Trust 3

qualified to elect to be treated as a QSST; however, a timely QSST election within the
meaning of § 1361(d)(2) was not filed. The failure to make the QSST election would
have terminated X’s S corporation election had it not already been terminated.

   X represents that all circumstances resulting in the termination of X’s S

corporation election were inadvertent and not motivated by tax avoidance. X further
represents that X filed returns consistent with X’s status as an S corporation and Trust
1, Trust 2, and Trust 3 filed returns consistent with rules applicable to QSSTs. X and its
shareholders agreed to make such adjustments (consistent with the treatment of X as
an S corporation) as may be required by the Secretary.

                                       LAW

    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 purposes of § 1361(b)(1)(B), a trust all

of which is treated (under subpart E of part 1 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(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
beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) of that
portion of the trust which consist of stock in an S corporation with respect to which the
election under § 1361(d)(2) is made.

PLR-121506-16 3

   Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary of the trust

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

  Section 1362(d)(2) 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 that if (1) an election under § 1362(a) by any

corporation was terminated under § 1362(d)(2) or (3), (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 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 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 termination, such corporation shall be treated as an S
corporation during the period specified by the Secretary.

                                  CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

X's S corporation election terminated beginning on Date 3, when the stock in X was
transferred to Trust 1 because a timely QSST election was not filed under § 1361(d)(2).
We conclude that the termination was inadvertent within the meaning of § 1362(f).
Moreover, had X’s S corporation election not already terminated on Date 3, it would
have terminated on Date 4 and Date 5, when stock was transferred to Trust 2 and Trust
3, respectively, and timely QSST elections were not filed for the trusts. Similarly, these
would have been inadvertent terminations within the meaning of § 1362(f).

    Therefore, we conclude that X will continue to be treated as an S corporation for

the period from Date 3 provided that X’s S corporation election was valid and was not
otherwise terminated under § 1362(d). This ruling is conditioned upon the income
beneficiaries of Trust 1, Trust 2, and Trust 3 filing a QSST election for each trust
effective upon the date the trust received shares of X. All elections must be filed with
the appropriate service center within 120 days of the date of this ruling. A copy of this
letter should be attached to each QSST election.

   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

PLR-121506-16 4

in this letter. Specifically, we express or imply no opinion regarding whether X is
otherwise eligible to be treated as an S corporation or whether Trust 1, Trust 2, and
Trust 3 are eligible to be treated as QSSTs.

    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. Pursuant to a power
of attorney on file, a copy of this letter is being sent to X’s authorized representatives.

                                   Sincerely,


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

Enclosures (2)
Copy of this Letter
Copy for 6110 purposes