S corporation received relief for omitted QSST elections

Plain-English summary

An S corporation’s stock passed through several trusts after a shareholder died. Eight trusts were intended to qualify as qualified subchapter S trusts, but the required QSST elections were not timely filed, causing or potentially causing the corporation’s S election to terminate on three dates. The corporation and shareholders consistently reported income as though S status continued and represented that the omissions were inadvertent, not tax avoidance or retroactive planning. The IRS treated the corporation as continuing to be an S corporation under section 1362(f). Relief was conditioned on filing QSST elections for all eight affected trusts within 120 days.

Ruling snapshot

• Question: May the corporation retain S status despite omitted QSST elections for trusts holding its stock?
• Outcome: approved, with continuous S status if all eight QSST elections are filed within 120 days
• Key authorities: IRC §§ 1361(d), 1362(d), 1362(f), and 645

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202004004                                              Third Party Communication: None
Release Date: 1/24/2020                                        Date of Communication: Not Applicable
Index Number: 1361.03-02, 1362.04-00
                                                               Person To Contact:
----------------------------------------------------------     --------------, ID No. -----------------
------------------------------------                           Telephone Number:
-------------------------------------                          ---------------------
---------------------------                                    Refer Reply To:
                                                               CC:PSI:B01
                                                               PLR-103727-19
                                                               Date:
                                                               August 30, 2019




LEGEND

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

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

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

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

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

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

Trust 4           =        ------------------------------------------------------------------------------------------
                  ----------------------------------------------------

Trust 5           =         -----------------------------------------------------------------------------------------
                  ---------------------------------------------------------------------------------------------------
                  -
----------------------------------------------------
PLR-103727-19                                             2


Trust 6           =         ------------------------------------------------
-----------------------------------------------------

Trust 7           =        ------------------------------------------------------------------------------------------
                  ----------------------------------------------------

Trust 8           =         -----------------------------------------------------------------------------------------
                  ---------------------------------------------------------------------------------------------------
                  -
                           -------------------------

Trust 9           =        ------------------------------------------------------------------------------------------
                  ----------------------------------------------------

Trust 10          =         -----------------------------------------------------------------------------------------
                  --------------------------------------------------------------------------------------------------
----------------------------------------------------

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

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

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

Date 4            =        ----------------------

Date 5            =        ------------------------

Date 6            =        ---------------------------

Date 7            =        ------------------

Date 8            =        -----------------------

Date 9            =        --------------------------

Date 10           =        ---------------------

Date 11           =        -----------------

Date 12           =        -----------------------

State             =        ---------
PLR-103727-19                                3


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

This responds to a letter dated February 25, 2019, and subsequent 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, and made a valid S election effective on Date 2.

A, an individual and eligible shareholder, owned shares in X. During A’s life, A
transferred shares of X to Trust 1, Trust 2, Trust 3, Trust 4, Trust 5 and Trust 6. Each of
which was treated as an eligible shareholder of X under § 1362(c)(2)(A)(i). On Date 3,
A died.

Although it was intended that Qualified Subchapter S Trust (QSST) elections be made
for Trust 1, Trust 2, Trust 3, Trust 4, and Trust 5 effective Date 7, two years after A’s
death, QSST elections were inadvertently not made for the trusts.

Trust 6 continued as Trust 7, an administrative trust. An election under § 645 was
made to treat Trust 7 as part of A’s estate for federal tax purposes. Because Trust 7
was treated as part of A’s estate, Trust 7 remained an eligible shareholder of X
throughout the period Trust 7 held X stock, as it did not hold any X shares after the
applicable date as defined in § 645(b)(2).

On Date 4, Trust 7 transferred a portion of its shares of X to Trust 8. Also on Date 4,
Trust 8 transferred most of those shares in X to Trust 9. On Date 5, Trust 9 transferred
all of its shares in X to B, an individual and eligible shareholder. On Date 6, B
transferred shares in X to trusts that are eligible shareholders of X under §
1362(c)(2)(A)(i).

On Date 8, Trust 7 transferred additional X shares to Trust 8 and Trust 10. On Date 9,
Trust 7 distributed the remaining shares in X to Trust 8. Also on Date 9, Trust 8
distributed a portion of its shares of X to B. On Date 10, B sold X shares to trusts that
are eligible shareholders of X under § 1362(c)(2)(A)(i).

Trust 8 was an eligible shareholder until Date 11 and Trust 10 was an eligible
shareholder until Date 12 under § 1.1361-1(h)(ii)(B). Although it was intended that
QSST elections be made for Trust 8 effective Date 11 and Trust 10 effective Date 12,
QSST elections were inadvertently not made for Trust 8 and Trust 10.

The failure to make QSST elections for Trust 1, Trust 2, Trust 3, Trust 4, Trust 5
effective Date 7 caused X’s S election to terminate on Date 7. Additionally, if X’s S
election had not already terminated on Date 7, X’s S election would have terminated on
PLR-103727-19                                 4

Date 11, Trust 8 and Trust 9 became ineligible shareholders and QSST elections were
not made. If X’s S election had not already terminated on Date 7 and Date 11, X’s S
election would have terminated on Date 12, when Trust 10 became an ineligible
shareholder and QSST elections were not made for it.

X represents that its S corporation election termination was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. Further, X represents that X
and its shareholders agree to make any adjustments required as a condition of
obtaining relief under the inadvertent termination rule as provided under § 1362(f) of the
Code that may be required by the Secretary.

X also represents that all income has been reported on all affected returns of X and all
of its shareholders consistent with the treatment of X as an S corporation, and that
neither X nor any of its shareholders intended to terminate its subchapter S election. In
addition, X represents that Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 8, Trust 9,
and Trust 10, qualify as QSSTs under section 1361(d) and have qualified as QSSTs
since Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 8, Trust 9, and Trust 10, acquired
their X stock. X represents that other than the inadvertent terminations, X has qualified
as a small business corporation at all times since its election on Date 2.

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.

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) 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) the trust is treated as a trust
described in § 1361(c)(2)(A)(i) and, for purposes of § 678(a), the beneficiary of the trust
is 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) provides that the term “qualified subchapter S trust” means 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
PLR-103727-19                                 5

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 a trust within the meaning of 663(c) shall be treated
as a separate trust for purposes of § 1361(d)(3) and § 1361(c).

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 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 § 1362(d)(2) or (3) or § 1361(b)(3)(C); (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 the 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.

Section 645(a) provides that if both the executor (if any) of an estate and the trustee of
a qualified revocable trust elect the treatment provided in this section, such trust shall
be treated and taxed as part of such estate (and not as a separate trust) for all taxable
years of the estate ending after the date of the decedent’s death and before the
applicable date.

Section 645(b) provides that for purposes of § 645(a) the term “applicable date” means
(A) if no return of tax imposed by chapter 11 of the Code is required to be filed, the date
which is 2 years after the date of the decedent’s death, and (B) if such a return is
required to be filed, the date which is 6 months after the date of the final determination
of the liability for tax imposed by chapter 11 of the Code.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on Date 7 and that if X’s S corporation election
had not terminated on Date 7 that X’s S corporation election would have terminated on
Date 11 and later on Date 12. We further conclude that the termination of X’s S election
PLR-103727-19                                 6

on Date 7, Date 11, and Date 12 was inadvertent within the meaning of § 1362(f).
Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation as of Date 7 and thereafter, provided that X’s S corporation election is not
otherwise terminated under § 1362(d). This ruling is contingent upon the filing of a
QSST election for Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 8, Trust 9, and Trust
10, respectively, within 120 days of the date of this letter. A copy of this letter should be
attached to each 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 whether Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 8, Trust 9, and
Trust 10, are otherwise valid QSSTs.

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.

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 representatives.


                                       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 of this letter for section 6110 purposes