The IRS grants inadvertent-termination relief after a grantor trust shareholder became ineligible when its owner died without a timely QSST election

Plain-English summary

An S corporation had a trust as one of its shareholders. That worked fine while the trust was a "grantor trust," meaning it was treated for tax purposes as owned by one living individual, which is an allowed type of S corporation shareholder. When that deemed owner died, the trust could stay an eligible shareholder only for a two-year grace period, and after that only if the beneficiary made a "qualified subchapter S trust" (QSST) election to keep the trust eligible. Here the QSST election was not filed on time, so the trust became an ineligible shareholder and the company's S corporation status automatically terminated. Once the problem was discovered, the trustee took steps to fix the trust's status, and the company represented that the trust had actually met all the QSST requirements the whole time, that everyone had kept filing consistently as an S corporation and QSST, and that the lapse was inadvertent and not tax-motivated. Section 1362(f) lets the IRS forgive an inadvertent termination when the company promptly fixes it and everyone agrees to any required adjustments. The IRS granted relief and ruled the company will be treated as remaining an S corporation without interruption. This is common cleanup relief for estate-driven S corporation problems, where a missed QSST election after a death would otherwise blow up the company's tax status.

Ruling snapshot

• Question: Was the termination of the company's S election (caused by a trust shareholder becoming ineligible after its deemed owner died with no timely QSST election) inadvertent, so that relief under § 1362(f) is available?
• Outcome: approved (inadvertent termination; treated as continuing S corporation from the termination date)
• Key authorities: IRC §§ 1362(f), 1362(d)(2)(A), 1361(a)(1), 1361(b)(1), 1361(c)(2)(A)(i)-(ii), 1361(d)(1)-(3); § 678(a); Treas. Reg. § 1.1361-1(j)(6)(ii)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202305004 Third Party Communication: None
Release Date: 2/3/2023 Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.03-00,
1361.03-01, 1361.03-02, Person To Contact:
1362.00-00, 1362.02-00, --------------------------, ID No. ----------------
1362.02-02, 1362.04-00 -----------------
Telephone Number:
---------------------------------------------------------- ---------------------
------------------------------------------ Refer Reply To:
---------------- CC:PSI:B01
------------------------------------------ PLR-109538-22
------------------------------ Date:
November 8, 2022

LEGEND
X = -----------------------------------------------------------------------
-----------------------

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

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

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

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

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

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

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

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

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

This responds to a letter dated April 7, 2022, and supplemental 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 within, X was incorporated
on Date 1, under the laws of State. Effective Date 2, X elected to be taxed as an S
corporation.

On Date 3, Trust became a shareholder of X. Until Date 4, Trust was a trust, all of which
was 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. On Date 4, the deemed
owner of Trust died. A Qualified Subchapter S Trust (QSST) election, effective Date 5,
was not timely filed for Trust. Accordingly, Trust became an ineligible shareholder of X
and X's S corporation status was terminated. On Date 6, the trustee of Trust took
remedial measures to convert Trust into an eligible shareholder.

X represents that Trust has at all times since Date 4 met the requirements of an QSST
within the meaning of § 1361(d). X also represents that X and its shareholders have
filed consistently with X's treatment as an S corporation, and Trust has filed consistently
as a QSST, at all times since Date 4. In addition, X represents that the termination of its
S corporation status 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 for the termination of
X's election as provided under § 1362(f) of the Code that 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 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 an S corporation shareholder.

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

Section 1361(d)(1) provides that a QSST whose beneficiary makes an election under §
1361(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the beneficiary
of such trust will be treated as the owner (for purposes of § 678(a)) 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) 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 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 one individual who is a citizen or
resident of the United States.

Section 1.1361-1(j)(6)(ii) of the Income Taxation 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 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 the corporation ceases to be a small business corporation. A termination of
an S corporation 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
was terminated under § 1362(d)(2) or (3); (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 termination occurred is a small business corporation; and (4)
the corporation for which the election was made or 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 within the meaning of § 1362(f) on Date 5
because Trust was an ineligible shareholder. Pursuant to the provisions of § 1362(f), X
will be treated as an S corporation from Date 5 and thereafter, provided X's S
corporation election is otherwise effective and not terminated under § 1362(d).

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,


                                                           /s/

                                  Laura Fields, Chief
                                  Branch 1
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

Enclosure
Copy for § 6110 purposes

cc: