Missed QSST election does not terminate S corporation status

Plain-English summary

A trust acquired shares of an S corporation and met the substantive requirements for a qualified subchapter S trust, but its beneficiary failed to make the QSST election on time. Without that election, the trust was an ineligible shareholder and the corporation's S election terminated. The corporation represented that the mistake was inadvertent, was not motivated by tax avoidance or retroactive planning, and that all affected returns treated it consistently as an S corporation. The IRS agreed that the termination was inadvertent and treated the corporation as continuously maintaining S status. Relief is conditioned on the trust filing the QSST election within 120 days, effective as of the date it acquired the shares. The IRS did not determine whether the corporation or trust otherwise met all S corporation and QSST requirements.

Ruling snapshot

• Question: Could the corporation retain S status after a qualifying trust failed to file its QSST election on time?
• Outcome: Approved, conditioned on filing the QSST election within 120 days
• Key authorities: IRC §§ 1361(d) and 1362(d) and (f); Treas. Reg. § 1.1361-1(j)(6)

Full text (IRS public release)

 Internal Revenue Service                                 Department of the Treasury
                                                          Washington, DC 20224

 Number: 202322018                                        Third Party Communication: None
 Release Date: 6/2/2023                                   Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                          Person To Contact:
 ----------------                                         ----------------------, ID No. -----------------
 ------------------------------------                     Telephone Number:
 --------------------------------                         --------------------
 ----------------------                                   Refer Reply To:
  -----------------------------                           CC:PSI:B03
                                                          PLR-123898-22
                                                          Date:
                                                          March 09, 2023

 RE: ----------------

Legend

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

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

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

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

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


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

        This letter responds to a letter dated December 5, 2022, submitted on behalf of X
by its authorized representative, 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. Effective Date 1, X elected to be taxed as an S corporation.

       On Date 2, Trust acquired shares in X. X represents that Trust met the
requirements to be treated as a qualified subchapter S trust (QSST) as described in
§ 1361(d), but a timely election to treat Trust as a QSST was not made. Therefore,
Trust was not an eligible S corporation shareholder and as a result, X’s S corporation
election terminated on Date 2.

      X represents that the circumstances resulting in the termination of its S
corporation election were inadvertent and were not motivated by tax avoidance or
PLR-123898-22                                 2

retroactive tax planning. Additionally, X represents that X and its shareholders filed all
returns consistent with X’s status as an S corporation. X and its shareholders agreed 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 1362(b)(1)(B) defines a “small business corporation”, in part, as a
domestic corporation that is not an ineligible corporation and that 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 the purposes of § 1362(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 is a permitted S
corporation shareholder.

       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 shall 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 the 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 one individual who is a citizen or
resident of the United States.

       Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary of the trust
must make the election by signing and filing with the service center with which the
corporation files its income tax return the applicable form or a statement that meets the
requirements of § 1.1361-1(j)(6)(ii)(A) through (E).

       Section 1.1361-1(j)(6)(iii) provides that the QSST election must be filed within the
time requirements of § 1.1361-1(j)(6)(ii)(A) through (E).
PLR-123898-22                                 3


      Section 1362(a) provides that a small business corporation may elect to be an S
corporation.

       Section 1362(d)(2)(A) provides that an election under § 1362(a) will 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 terminated under § 1362(d)(2) or (3); (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 of the corporation at any
time during the period specified under § 1362(f), agrees to make the adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary for that period, then, notwithstanding the circumstances
resulting in such termination, the corporation shall 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 2 when Trust became an ineligible
shareholder. We further conclude that the termination was inadvertent within the
meaning of § 1362(f). X will be treated as continuing to be an S corporation from Date 2
and thereafter, provided that X’s S corporation election was valid and not otherwise
terminated under § 1362(d).

        This relief is contingent on Trust filing a QSST election with the appropriate
service center, within 120 days from the date of this letter effective Date 2. A copy of
this letter should be attached to the election.

       Except as specifically ruled 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 and the regulations thereunder. Specifically, we express or imply no opinion
regarding X’s eligibility to be an S corporation or Trust's eligibility as a QSST.

      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.
PLR-123898-22                                4

      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.

      In accordance with the power of attorney on file with this office, we are sending a
copy of this letter to X’s authorized representatives.


                                                 Sincerely,

                                                  Associate Chief Counsel
                                                 (Passthroughs & Special Industries)


                                                        /s/ Margaret Burow
                                            By: _____________________________
                                                Margaret Burow
                                                Senior Counsel, Branch 3
                                                Office of the Associate Chief Counsel
                                                (Passthroughs & Special Industries)


Enclosure
      Copy for § 6110 purposes



cc: