Corporation keeps S status after beneficiary missed QSST election

Plain-English summary

Shares of an S corporation were transferred to a trust that met the substantive requirements for a qualified subchapter S trust, but the income beneficiary failed to make the required QSST election. The trust therefore became an ineligible shareholder and inadvertently terminated the corporation’s S election. The trust later distributed all of its shares to the beneficiary, and all affected parties had filed consistently with continued S and QSST treatment. The IRS ruled that the termination was inadvertent, treated the corporation as continuously eligible for S status, and treated the trust as a QSST during the period it held the shares. Relief required the beneficiary to file the missing QSST election within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after a trust beneficiary failed to timely elect QSST treatment?
• Outcome: approved, subject to filing the QSST election within 120 days
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. § 1.1361-1(j)(7)

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202248002                                             Third Party Communication: None
 Release Date: 12/2/2022                                       Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                               Person To Contact:
 -----------------------------                                 ------------------------, ID No. -----------------
 ---------------------------                                   Telephone Number:
 --------------                                                --------------------
 --------------------------------------------                  Refer Reply To:
 ----------------------------------------------------------    CC:PSI:B01
                                                               PLR-105824-22
                                                               Date:
                                                               August 31, 2022


                                                      LEGEND

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

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

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

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

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

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

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

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

 Year 1          =       -------




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

This letter responds to a letter dated February 17, 2022, submitted on behalf of X by its
authorized representatives requesting a ruling under § 1362(f) of the Internal Revenue
Code (Code).
PLR-105824-22                                 2

                                           Facts

According to the information submitted, X was incorporated under the laws of State on
Date 1 and made an election to be treated as an S corporation effective Date 2. On
Date 3, shares of X stock were transferred to Trust. It is represented that as of Date 3,
Trust satisfied the qualified subchapter S trust (QSST) requirements under § 1361(d)(3).
However, in Year 1, X learned that A, the income beneficiary of Trust, had failed to
make an election under § 1362(d)(2) to treat Trust as a QSST effective Date 3.
Consequently, Trust was an ineligible shareholder of X and X’s S corporation election
inadvertently terminated on Date 3. Subsequently on Date 4, Trust distributed all of its
shares of X stock to A.

X represents that X and its shareholders have filed tax returns consistent with X having
a valid S corporation election in effect as of Date 2. X also represents that both Trust
and A have filed tax returns in a manner consistent with Trust having valid a QSST
election in effect from Date 3 to Date 4. X and its shareholders have agreed to make
any adjustment that the Commissioner may require, consistent with the treatment of X
as an S corporation.

                                    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, in part, that, for purposes of subchapter S, the term
“small business corporation” means a domestic corporation which is not an ineligible
corporation and which does not 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(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.
PLR-105824-22                                 3

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 § 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. 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 1.1361-1(j)(7)(i) of the Income Tax Regulations provides that the income
beneficiary who makes the QSST election and is treated (for purposes of § 678(a)) as
the owner of that portion of the trust that consists of S corporation stock is treated as the
shareholder for purposes of §§ 1361(b)(1), 1366, 1367, and 1368.

Section 1362(d)(2) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the first day of the taxable year for which a
corporation is an S corporation) such corporation ceases to be a small business
corporation. A termination of an S corporation election under § 1362(d)(2) is effective on
and after the date of cessation.

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) or
to obtain shareholder consents or was terminated under § 1362(d)(2), (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 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 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 status inadvertently terminated on Date 3 when Trust became an
PLR-105824-22                                 4

ineligible shareholder. We further conclude that the circumstances resulting in the
termination of X’s S corporation election were inadvertent within the meaning of
§ 1362(f). Pursuant to the provisions § 1362(f), we rule that 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 not otherwise terminated under § 1362(d) for reasons
not addressed in this letter. In addition, Trust will be treated as a QSST from Date 3 until
Date 4.

This ruling is contingent on A, as the beneficiary of Trust, 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 above, we express or imply no opinion as to the federal
income 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 was a
valid QSST.

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

The ruling contained in this letter is based on 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 a power of attorney on file with this office, we are sending a copy of this
letter to your authorized representatives.

                                          Sincerely,



                                           Jennifer N. Keeney
                                           Senior Counsel, Branch 1
                                           Office of the Associate Chief Counsel
                                           (Passthroughs & Special Industries)


Enclosure
Copy for § 6110 purposes


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