IRS restores S status after a beneficiary missed a QSST election

Plain-English summary

An S corporation's shares were held by a grantor trust whose deemed owner died. The trust remained an eligible shareholder temporarily, then transferred the shares to a second trust that met the substantive requirements for a qualified subchapter S trust. The second trust's income beneficiary failed to file the required QSST election, causing the corporation's S election to terminate, although the beneficiary reported the trust's share of income or loss consistently with QSST treatment. The IRS found the termination inadvertent and treated the corporation as continuing its S status. Relief was conditioned on the beneficiary filing a QSST election effective on the transfer date within 120 days, and the ruling did not decide whether the corporation or trust otherwise met the applicable eligibility rules.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after a trust beneficiary failed to make a timely QSST election?
• Outcome: approved (S status continued if the beneficiary filed the QSST election within 120 days)
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d), 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii)

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202024007                                              Third Party Communication: None
 Release Date: 6/12/2020                                        Date of Communication: Not Applicable
 Index Number: 1362.04-00                                       Person To Contact:
                                                                -----------------, ID No. -----------------
 ----------------------------------------                       Telephone Number:
 ------------------------------------------------               --------------------
 ---------------------                                          Refer Reply To:
 -------------                                                  CC:PSI:B03
 ---------------------------------                              PLR-123369-19
                                                                Date:
                                                                March 03, 2020




Legend

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

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

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

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

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

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

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

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

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

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


Dear ----------------:
PLR-123369-19                                 2

      This letter responds to a letter dated October 1, 2019, and subsequent
correspondence, submitted on behalf of X from X’s authorized representative,
requesting inadvertent termination relief pursuant to § 1362(f) of the Internal Revenue
Code (the Code).

                                          FACTS

        The information submitted states that X was incorporated under the laws of State
on Date 1 and elected to be an S corporation effective Date 2. On Date 2, Trust 1
owned shares of X stock. X represents that Trust 1 was treated under subpart E of part I
of subchapter J of chapter 1 of the Code as entirely owned by A and, thus, an eligible
shareholder under § 1361(c)(2)(A)(i). On Date 3, A died. Under § 1361(c)(2)(A)(ii),
Trust 1 remained an eligible shareholder until the trustees of Trust 1 transferred
Trust 1’s shares of X stock to Trust 2 on Date 4. X represents that Trust 2 satisfied the
qualified subchapter S trust (QSST) requirements under § 1361(d)(3). However, B,
Trust 2’s income beneficiary, failed to make an election under § 1361(d)(2) to treat
Trust 2 as a QSST effective Date 4. Therefore, X’s S corporation election terminated on
Date 4.

       X represents that the failure to file a QSST election was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. X represents that B reported
Trust 2’s allocable share of X’s income (or loss) consistent with the treatment of Trust 2
as a QSST on all affected returns. Finally, 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.
PLR-123369-19                                 3

       Section 1361(c)(2)(A)(ii) provides that for purposes of § 1361(b)(1)(B), a trust
which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed
owner and which continues in existence after such death may be a shareholder, but
only for the 2-year period beginning on the day of the deemed owner’s death.

         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 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) 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 1.1361-1(j)(6)(ii) of the Income Tax Regulations provides that the current
income beneficiary of the trust must make the election under § 1361(d)(2) by signing
and filing, with the service center with which the S corporation files its income tax return,
the applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

       Section 1362(d)(2)(A) provides that an election under § 1362(a) shall 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 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 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,
PLR-123369-19                                 4

notwithstanding the circumstances resulting in the termination, the corporation will be
treated as an S corporation during the period specified by the Secretary.

                                      CONCLUSION

       Based solely on the facts submitted and representations made, we conclude that
X’s S corporation election terminated on Date 4 when Trust 2 became an ineligible
shareholder. We further conclude that the termination constituted an inadvertent
termination 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 4 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 2 effective Date 4,
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 2’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 representatives.

                                                  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 of this letter for §6110 purposes

cc: