Corporation preserves S status after trust beneficiaries miss QSST elections

Plain-English summary

A trust held all shares of a corporation from the date the corporation elected S status, but the trust's beneficiaries never filed qualified subchapter S trust elections. The trust had separate beneficiary shares that met the substantive QSST terms, yet it was treated as a complex trust for several years and paid tax at the trust level. The IRS concluded that the corporation's ineffective S election resulted from the beneficiaries' inadvertent failure. It treated the corporation as an S corporation from the intended effective date. Relief required every beneficiary to file a retroactive QSST election for the beneficiary's separate share and the trustee to file specified amended returns within 120 days.

Ruling snapshot

• Question: May the corporation retain S status after the shareholder trust's beneficiaries failed to make timely QSST elections?
• Outcome: Approved with conditions. Retroactive QSST elections and amended trust returns must be filed within 120 days.
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d)(2), 1362(f); Treas. Reg. § 1.1362-4(b)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201721004 Third Party Communication: None
Release Date: 5/26/2017 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------ --------------------------, ID No. ----------------
------------------------- -----------------
-------------------------- Telephone Number:
------------ ---------------------
-------------------------------------------- Refer Reply To:
CC:PSI:B03
PLR-127058-16
Date:
February 23, 2017

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

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

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

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

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

X = --------

Y = ----------------

Year 1 = -------

Year 2 = -------

Year 3 = -------

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

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

PLR-127058-16 2

   This responds to a letter dated August 29, 2016, and supplemental information,

submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

                                     FACTS

  According to the information submitted and representations made, X was

incorporated on Date 1 under the laws of State. Effective Date 1, X elected to be taxed
as an S corporation under § 1362 of the Code.

    X’s shares were originally held by Trust. Trust was settled by A on Date 1.

Trust’s beneficiaries inadvertently failed to make an election under § 1361(d)(2) to treat
Trust as a qualified subchapter S trust (QSST), but they intended to make the election
effective Date 1.

    Trust has X beneficiaries. Each beneficiary has a separate and independent

interest in Trust within the meaning of § 663(c). Trust’s trust agreement requires that,
with respect to each separate and independent interest in Trust, there is only one
income beneficiary and any corpus distributed during the life of such income beneficiary
may be distributed only to such beneficiary. Further, the income interest of the current
income beneficiary of each separate and independent interest in Trust terminates on the
earlier of the beneficiary’s death or termination of the Trust, and upon the termination of
Trust during the life of the current income beneficiary, Trust must distribute all of its
assets to that beneficiary.

   From Year 1 through Year 2, Trust was inadvertently treated as a complex trust

because Trust did not distribute all of its income to Trust’s beneficiaries. All income was
reported and all tax was paid at the trust level.

    On Date 2, Trust’s new accounting firm discovered the incorrect treatment of

Trust. During this time, it was also discovered that a QSST election had never been
filed on behalf of Trust.

   X represents that its S corporation election termination was inadvertent and was

not motivated by tax avoidance or retroactive tax planning. Trust has agreed to file
amended returns consistent with being a QSST. Further, X and its shareholders
represent that they will make any adjustments required as a condition of obtaining relief
under the inadvertent termination rule provided in § 1362(f) that may be required by the
Secretary.

                              LAW AND ANALYSIS

PLR-127058-16 3

    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 “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
one class of stock.

   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 I of subchapter J of chapter 1) 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)(3) defines “qualified subchapter S trust” (QSST) as a trust, (A)

the terms of which require that (i) during the life of the current income beneficiary, there
shall be only 1 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 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, and (B) all of the income (within the
meaning of section 643(b)) of which is distributed (or required to be distributed)
currently to 1 individual who is a citizen or resident of the United States. A substantially
separate and independent share of the trust within the meaning of § 663(c) shall be
treated as a separate trust for purposes of §§ 1361(c) and (d).

   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 shall be treated as a
trust described in § 1361(c)(2)(A)(i), (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, and (C)
for purposes of applying §§ 465 and 469 to the beneficiary of the trust, the disposition of
the S corporation stock by the trust shall be treated as a disposition by such beneficiary.

    Section 1361(d)(2) provides that a beneficiary of a qualified subchapter S trust

(or his legal representative) may elect to have § 1361(d)(1) apply. An election under
§ 1362(d)(2) shall be made separately with respect to each corporation the stock of
which is held by the trust.

  Section 1362(d)(2)(A) provides that an election under § 1362(a) will be

terminated whenever (at any time on or after the first day of the first taxable year for
PLR-127058-16 4

which the corporation is an S corporation) such corporation ceases to be a small
business corporation.

    Section 1362(f) provides that if an election under § 1362(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) and the Secretary determines that the
circumstances resulting in such ineffectiveness were inadvertent, and 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 the corporation for which the election was
made 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, such corporation shall be treated as an S corporation during the
period specified by the Secretary.

    Section 1.1362-4(b) of the Income Tax Regulations provides that the

determination of whether an invalid S corporation election was inadvertent is made by
the Commissioner. The corporation has the burden of establishing that under the
relevant facts and circumstances the Commissioner should determine that the invalid
election was inadvertent. The fact that the invalidity of the election was not reasonably
within the control of the corporation or the fact that the circumstances took place without
the knowledge of the corporation, notwithstanding its due diligence to safeguard itself
against such circumstance, tends to establish the invalidity of the election was
inadvertent.

                                  CONCLUSION

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

that X's S corporation election was ineffective on Date 1 due to the beneficiaries’
inadvertent failure to make a QSST election for Trust. Pursuant to the provisions of
§ 1362(f), X will be treated as an S corporation from Date 1.

    This ruling is contingent upon, within 120 days from the date of this letter, each

beneficiary filing with the appropriate service center an election to treat Trust as QSST
effective from Date 1 with respect to each beneficiary’s separate share of Trust. This
ruling is also contingent upon the trustee filing, within 120 days from the date of this
letter, amended returns for Year 2 and Year 3 to conform with Trust’s treatment as a
QSST from Date 1. A copy of this letter should be attached to the QSST election and
the amended returns.

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

concerning the federal tax consequences of the facts of this case under any other
PLR-127058-16 5

provision of the Code. Specifically, we express or imply no opinion regarding X’s
eligibility to be an S corporation, or Trust’s eligibility to be a QSST.

  This ruling is directed only to the taxpayer that 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 representatives.

                                          Sincerely,




                                          James A. Quinn
                                          Senior Counsel, Branch 3
                                          Office of the Associate Chief Counsel
                                          (Passthroughs & Special Industries)

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