S corporation gets inadvertent-termination relief after a trust missed its QSST election

Plain-English summary

An S corporation had a trust as one of its shareholders. While that trust was a grantor trust (treated as owned by one individual), it was an eligible S corporation shareholder. When the trust stopped being a grantor trust, it could have stayed eligible as a "qualified subchapter S trust" (QSST), but only if the income beneficiary filed the required QSST election. The beneficiary did not, so the trust became an ineligible shareholder and the company's S election terminated. The company asked the IRS to treat the lapse as inadvertent under section 1362(f). The IRS agreed, finding the termination was not driven by tax avoidance, and ruled the company will be treated as continuing to be an S corporation without a gap, on the condition that the beneficiary files the QSST election (retroactive to the trigger date) within 120 days. This matters because a missed one-page election would otherwise have cost the company its pass-through tax status; the relief restores it as long as the cure is completed on time.

Ruling snapshot

• Question: Was the S corporation's termination inadvertent when a trust shareholder's beneficiary failed to make a timely QSST election, so it can continue as an S corporation?
• Outcome: approved (inadvertent termination relief granted, contingent on a QSST election within 120 days)
• Key authorities: IRC §§ 1361(b), 1361(c)(2), 1361(d), 1362(d)(2), 1362(f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201848001
Third Party Communication: None
Release Date: 11/30/2018
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Refer Reply To:
CC:PSI:B03
PLR-102751-18
Date:
August 30, 2018

LEGEND:

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

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

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

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

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

A = ------------------------------
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B = ------------------------------
--------------------------

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

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

This letter responds to a letter dated January 16, 2018, and supplemental information, submitted on behalf of X by X's authorized representative, requesting relief under § 1362(f) of the Internal Revenue Code (the Code).
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FACTS

According to the information submitted and representations made, X was incorporated on Date 1 under the laws of State and elected to be an S corporation effective Date 2.

Prior to Date 3, Trust, a shareholder of X, was a grantor trust that was treated (under subpart E of part 1 of subchapter J of chapter 1) as owned by A. On Date 3, Trust ceased to be a grantor trust. X represents that as of Date 3, Trust satisfied the qualified subchapter S trust (QSST) requirements under §1361(d)(3). However, B, Trust’s income beneficiary, failed to make an election under § 1361(d)(2) to treat Trust as a QSST effective Date 3. Therefore, X’s S corporation election terminated on Date 3.

X represents that the circumstances resulting in the termination of its S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X represents that it and its shareholders have filed tax returns consistent with the treatment of X as an S corporation and Trust as a QSST. X and its shareholders agree to make any adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary.

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 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 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
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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 one individual who is a citizen or resident of the United States.

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 QSST (or his legal representative) may elect to have § 1361(d) 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 which the corporation is an S corporation) such 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 the 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 facts submitted and the representations made, we conclude that X's S corporation election was terminated on Date 3 when Trust became an
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ineligible shareholder. We also conclude that the termination was inadvertent 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 X’s S corporation election was valid and was not otherwise terminated under §1362(d).

This ruling is contingent on B filing a QSST election for Trust 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 to the QSST election.

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 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.

The ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the ruling request, it is subject to verification on examination.

Pursuant to the power of attorney on file with this office, we are sending a copy of this letter to your authorized representative.

Sincerely,

Mary Beth Carchia
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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