Corporation retains S status after beneficiary misses QSST election

Plain-English summary

Shares of an S corporation were held in a grantor trust owned by a married couple. When one spouse died, the trust divided and part of the stock passed to a new trust that qualified to elect as a qualified subchapter S trust. The surviving beneficiary did not make the QSST election on time, which terminated the corporation's S election. The IRS found the termination inadvertent and allowed continuous S treatment. Relief was conditioned on the beneficiary filing a QSST election effective on the termination date within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after a trust beneficiary failed to make a timely QSST election?
• Outcome: approved
• Key authorities: IRC §§ 1361(d) and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201716003 Third Party Communication: None
Release Date: 4/21/2017 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
---------------------------------- ----------------------, ID No. -------------
---------------------------------------- Telephone Number:
------------------ ---------------------
------------------------------- Refer Reply To:
CC:PSI:B01
PLR-121903-16
Date:
January 05, 2017

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

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

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

Trust 1 = -----------------------------------------------------------------------------

Trust 2 = ---------------------------------------------------------------------------------------------------
-------

Trust 3 = ---------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------
-----------------------

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

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

Date 2 = -----------------------
---------------------------------------------------------------------------------------------------
Date 3 = -------------------------

Dear --------------
PLR-121903-16 2

This letter responds to a letter dated June 27, 2016, and subsequent correspondence,
submitted on behalf of X, requesting relief under § 1362(f) of the Internal Revenue
Code.

Facts

The information submitted states that X was formed under the laws of State on Date 1.
X filed a timely election under § 1362(a) to be taxed as an S corporation effective Date

1. Shares of X stock were transferred to Trust 1 on Date 2. Trust 1 was treated (under
   subpart E of part I of subchapter J of chapter 1 of the Internal Revenue Code) as owned
   by spouses A and B. Thus, Trust 1 was a permitted S corporation shareholder pursuant
   to § 1361(c)(2)(A)(i). A died on Date 3.

Trust 1’s agreement provides that, upon the death of either A or B, the trustee shall
divide Trust 1 into two separate trusts, designated as Trust 2 and Trust 3. Effective
Date 3, the trustee distributed the X stock held by Trust 1 to Trust 2 and Trust 3. Trust
2 was treated (under subpart E of part I of subchapter 1) as owned by B. Thus, Trust 2
was a permitted S corporation shareholder pursuant to § 1361(c)(2)(A)(i).

X represents that Trust 3 has at all times qualified to elect to be a Qualified Subchapter
S Trust (QSST) within the meaning of § 1361(d)(3); however, B, the beneficiary of Trust
3, failed to timely file a QSST election for Trust 3.

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. Additionally, X represents that X and its shareholders have filed their federal
income tax returns consistent with having a valid S corporation election in effect for X.
X and its shareholders have agreed 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 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.
PLR-121903-16 3

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 a shareholder of an S corporation.

Section 1361(d)(1) provides that, in the case of a QSST with respect to which a
beneficiary makes an election under § 1361(d)(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)(2)(A) provides that a beneficiary of a QSST (or his legal representative)
may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that an election
under § 1361(d)(2) shall be effective up to 15 days and 2 months before the date of the
election.

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 income 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 (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 1362(f) provides that if (1) an election under § 1362(a) by any corporation (A)
was not effective for the tax 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 paragraph (2) or (3) of § 1362(d); (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 event resulting in the ineffectiveness or termination, steps were taken
(A) so that the corporation is a small business corporation, or (B) to acquire the required
shareholder consents, 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 such 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 or termination, the
corporation shall be treated as an S corporation during the period specified by the
Secretary.
PLR-121903-16 4

Conclusion

Based solely on the facts submitted and representations made, we conclude X’s S
election terminated on Date 3 resulting from the failure of B, as the beneficiary of Trust
3, to make the election under § 1361(d)(2).

We further conclude that the termination was inadvertent within the meaning of
§ 1362(f). Accordingly, X will be treated as continuing to be an S corporation from Date
3 and thereafter, provided that its S corporation election was otherwise valid and was
not otherwise terminated under § 1362(d). Trust 3 will be treated as a QSST from Date
3 and thereafter, provided that B files a QSST election effective Date 3 with the
appropriate service center within 120 days from the date of this letter. A copy of this
letter should be attached the QSST election.

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 or implied concerning the eligibility of X
to be an S corporation.

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 X’s authorized representative.

                                   Sincerely,


                                   Laura C. Fields
                                   Laura C. Fields
                                   Senior Technician Reviewer, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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