Late QSST election excused, so a company keeps its S corporation status

Plain-English summary

A small business had elected to be taxed as an S corporation, and one of its
shareholders was a trust set up by a married couple who were its grantors,
beneficiaries, and trustees. When the first spouse died, the surviving spouse
failed to make the required qualified subchapter S trust (QSST) election in
time, which technically ended the company's S corporation election. The
surviving spouse later died too, and the trust kept holding the stock as part
of the estate. The company asked the IRS to treat the lapse as inadvertent
under IRC § 1362(f). The IRS agreed the termination was inadvertent and ruled
that the company will be treated as continuing to be an S corporation, as
long as a proper QSST election is filed for the trust within 120 days of the
letter. This matters because a lost S election can trigger corporate-level
tax and disrupt shareholders' pass-through treatment.

Ruling snapshot

• Question: Was the termination of the company's S corporation election, caused by a missed QSST election after a shareholder's death, inadvertent under IRC § 1362(f)?
• Outcome: approved (termination ruled inadvertent; S status continues if a QSST election is filed within 120 days)
• Key authorities: IRC §§ 1361(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202007001 Third Party Communication: None
Release Date: 2/14/2020 Date of Communication: Not Applicable
Index Number: 1361.03-02, 1362.02-02,
1362.04-00 Person To Contact:
----------------, ID No. ------------------
-------------------------- Telephone Number:
------------------------------------------- --------------------
------------------------------ Refer Reply To:
---------------------------------------- CC:PSI:B01
PLR-103686-19
Date:
August 28, 2019

LEGEND

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

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

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

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

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

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

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

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

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

State = ---------
PLR-103686-19 2

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

This responds to a letter dated December 28, 2018, submitted on behalf of X by X’s
authorized representative, and supplemental correspondence, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted, X was incorporated on Date 1, under the laws of
State. Effective Date 2, X elected to be taxed as an S corporation.

Trust was an eligible shareholder of X. A and B, a married couple, were the grantors of
Trust and during their lives they were the beneficiaries and trustees of Trust. On Date
3, A died, leaving B as the beneficiary. B failed to make a timely qualified subchapter S
trust (QSST) election for Trust. Thus, X’s S corporation election terminated on Date 4.
B died on Date 5. The shares of X held by Trust continued to be held by Trust as part
of B’s estate after B’s death.

X represents that Trust qualified as a QSST under § 1361(d) as of Date 4 and
thereafter. X further represents that the circumstances resulting in the failure to file a
QSST election for Trust was inadvertent and was not motivated by tax avoidance or
retroactive tax planning. X and its shareholders have agreed to make such 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) 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.

Section 1361(d)(1) provides that a QSST whose beneficiary makes an election under
§ 1362(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the QSST’s
beneficiary will be treated as the owner (for purposes of § 678(a)) of that portion of the
PLR-103686-19 3

QSST’s S corporation stock to which the election under § 1361(d)(2) applies. Under
§ 1361(d)(2)(A), a beneficiary of a QSST may elect to have § 1361(d) apply. Under
§ 1361(d)(2)(D), this election will be effective up to 15 days and two months before the
date of the election.

Section 1361(d)(3) provides that for purposes of § 1361(d), 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 the life of the current 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 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 1 individual who is a citizen or resident of the United States.

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 1st 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 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); (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 circumstances resulting in such ineffectiveness or 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
ineffectiveness or 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 the representations made, we conclude that
X’s S corporation election terminated on Date 4 as a result of the failure to make a
timely QSST election for Trust. We further conclude that the termination of X’s S
election on Date 4 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
2 and thereafter, provided that a QSST election is made on behalf of B for Trust with an
effective date of Date 4, with the appropriate service center within 120 days from the
PLR-103686-19 4

date of this letter, and X’s S corporation election is not otherwise terminated under
§ 1362(d). A copy of this letter must 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.

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,



                                  David R. Haglund
                                  David R. Haglund
                                  Branch Chief, 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

cc: