S corporation saved after three trusts filed defective QSST elections

Plain-English summary

An S corporation's shares moved through a series of trusts after its original shareholder died. When that shareholder died, a grantor trust holding the stock stopped qualifying automatically, and the shares passed to another trust under the will. That trust could have kept the S corporation eligible by making a "qualified subchapter S trust" (QSST) election, but the election was not properly signed, so the trust became an ineligible shareholder and the company's S corporation status terminated. Two other trusts that also held shares filed QSST elections too, but those were likewise not signed by the beneficiary, which would have terminated the S election on a later date anyway. The company said none of this involved tax avoidance, just paperwork that fell short. The IRS agreed the terminations were inadvertent under section 1362(f) and ruled that the corporation may be treated as remaining an S corporation, provided the beneficiaries of all three trusts now file properly signed QSST elections (backdated to the correct effective dates) within 120 days and everyone files consistent tax returns. If those conditions are not met, the relief is void.

Ruling snapshot

• Question: Were the terminations of the corporation's S election, caused by improperly signed QSST elections for three trusts, inadvertent under IRC § 1362(f) so the S status can be preserved?
• Outcome: Approved (inadvertent termination relief granted, contingent on filing valid QSST elections within 120 days)
• Key authorities: IRC §§ 1361(c)(2), 1361(d) (QSST rules), 1362(d)(2), and 1362(f); Treas. Reg. § 1.1361-1(j)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202233004
Third Party Communication: None
Release Date: 8/19/2022
Date of Communication: N/A
Index Number: 1361.00-00, 1361.01-00,
1361.03-00, 1361.03-03,
Person To Contact:
1362.00-00, 1362.02-00,
----------------------, ID No. -----------------
1362.04-00
Telephone Number:
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Refer Reply To:
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PLR-123711-21
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Date:
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May 17, 2022

Legend

X = ---------------------------
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State = --------

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

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

Trust 2 = --------------------------------------------
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Trust 3 = -------------------------------------
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Trust 4 = ---------------------------------
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Date 1 = ---------------------

Date 2 = ----------------
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Date 3 = -------------------

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

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

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

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

This letter responds to a letter dated November 1, 2021, submitted on behalf of X by its authorized representatives, requesting a ruling under § 1362(f) of the Internal Revenue Code (Code).

Facts

The information submitted states that X was incorporated under the laws of State on Date 1. X elected to be an S corporation effective Date 2. A was an initial shareholder of X. On Date 3, A transferred shares of X to Trust 1. X represents that Trust 1 was an eligible S corporation shareholder under § 1361(c)(2)(A)(i).

On Date 4, A died, causing Trust 1 to cease being a grantor trust. At the time of A’s death, Trust 2 and Trust 3 were shareholders of X. X represents that Trust 2 and Trust 3 were eligible shareholders under § 1361(c)(2)(A)(i). Under § 1361(c)(2)(A)(ii), Trust 2 and Trust 3 remained eligible shareholders of X for the two-year period after A’s death.

Also on Date 4, pursuant to the terms of A’s will, Trust 1 transferred its shares in X from Trust 1 to Trust 4. X represents that Trust 4 was eligible to be a QSST under § 1361(d)(3), however, the QSST election for Trust 4 was not properly signed. Consequently, Trust 4 was an ineligible shareholder, and, as a result, X’s S corporation election terminated on Date 4.

X represents that beginning Date 4, Trust 2 and Trust 3 qualified as QSSTs under § 1361(d)(3). However, the QSST elections made by Trust 2 and Trust 3, with an effective date of Date 5, were not signed by the beneficiary. As a result, X’s S corporation election, had it not otherwise terminated on Date 4, would have terminated on Date 6.

X represents that there was no tax avoidance or retroactive tax planning involved in the failure of Trust 2, Trust 3, or Trust 4 to make valid QSST elections. X and its shareholders agree to make any adjustments consistent with the treatment of X as an S
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corporation and Trust 2, Trust 3, and Trust 4 as eligible shareholders, 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)(B) provides that the term “small business corporation” means a domestic corporation that is not an ineligible corporation and that does not, among other requirements, 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.

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 of the Code) as owned by an individual who is a citizen or resident of the United States may be a shareholder.

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

Section 1361(c)(2)(B)(i) provides that for purposes of § 1361(b)(1), in the case of a trust described in § 1361(c)(2)(A)(i), the deemed owner shall be treated as the shareholder.

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 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 may elect to have § 1361(d)(1) apply.

Section 1361(d)(2)(D) provides that an election under § 1362(d)(2) shall be effective up to 15 days and 2 months before the date of the election.

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 only be 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
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shall terminate on the earlier of such beneficiary’s death or the termination of the trust, and (iv) upon 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 § 643(b)) of which is distributed (or required to be distributed) currently to 1 individual who is a citizen or a resident of the United States.

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

Section 1362(a)(1) provides that, except as provided in § 1362(g), a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1362(d)(2)(A) provides that an election under § 1362(a) is 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(d)(2)(B) provides that any termination under § 1362(d)(2)(A) is effective on and after the date of cessation.

Section 1362(f) provides that if (1) an election under § 1362(a) or § 1361(b)(3)(B)(ii) by any corporation (i) 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) or to obtain shareholder consents, or (ii) was terminated under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (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 election was made or the termination occurred is a small business corporation or a QSub, as the case may be, or to acquire the required shareholder consents; and (4) the corporation for which the election was made or the termination occurred, and each person who was a shareholder of the corporation at any time during the period specified pursuant to § 1362(f), agree to make the adjustments (consistent with the treatment of the corporation as an S corporation or a QSub, as the case may be) as may be required by the Secretary with respect to this period, then, notwithstanding the circumstances resulting in such ineffectiveness or termination, the corporation shall be treated as an S corporation or a QSub, as the case may be, 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 4 became an ineligible shareholder, and that the termination was inadvertent within the meaning of § 1362(f).
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We also conclude that if X’s S corporation election had not already terminated on Date 4, X’s S corporation election would have terminated on Date 6, when Trust 2 and Trust 3 became ineligible shareholders of X. Consequently, we rule that X will be treated as an S corporation from Date 4, and thereafter provided that X’s S corporation election is otherwise valid and not otherwise terminated under § 1362(d).

These rulings are contingent on the beneficiary (or beneficiary’s representative) of Trust 4 filing an QSST election effective Date 4, with the appropriate service center within 120 days of the date of this letter. A copy of this letter should be attached to the QSST election. In addition, this ruling is contingent on the beneficiary (or beneficiary’s representative) of Trust 2 and Trust 3 filing QSST elections effective Date 5, with the appropriate service center within 120 days of the date of this letter. A copy of this letter should be attached to each QSST election. Additionally, X and its shareholders must file any original and amended returns for all open taxable years consistent with the relief granted in this letter. If the above conditions are not met, then this ruling is null and void.

Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the facts described above under any other provision of the Code, including whether X was otherwise a valid S corporation or whether Trust 2, Trust 3, or Trust 4, were or are otherwise valid QSSTs within the meaning of § 1361(d)(3).

The rulings contained in this letter are 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 rulings requested, it is subject to verification on examination.

Pursuant to a power of attorney on file, we are sending a copy of this letter to X’s authorized representatives.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited for precedent.

Sincerely,

Richard T. Probst
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)
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Enclosure:
Copy for § 6110 purposes

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