S corporation election saved after four trusts missed their QSST elections

Plain-English summary

An S corporation's shares passed, after the original shareholder died, from a grantor trust into four new trusts. Each of those trusts could have qualified to hold S corporation stock as a Qualified Subchapter S Trust (QSST), but a trust only counts as a QSST if its income beneficiary files a specific election, and here none of the four beneficiaries did. Because an S corporation can only have eligible shareholders, the missed elections made the four trusts ineligible and automatically terminated the company's S status. The company asked the IRS for relief under § 1362(f), which lets the IRS forgive an inadvertent termination. The IRS agreed the failure was inadvertent, so it will treat the company as remaining an S corporation and treat the four trusts as QSSTs from the transfer date forward. The relief is conditional: each beneficiary must file a QSST election within 120 days, and the trusts must file amended returns and flag their QSST status going forward. This spares the corporation and its owners the tax fallout of an accidental S-election loss.

Ruling snapshot

• Question: Was the termination of the company's S election, caused by four trusts failing to make QSST elections, inadvertent and eligible for relief under § 1362(f)?
• Outcome: approved (S status and QSST treatment preserved from the transfer date, conditioned on late QSST elections and amended returns)
• Key authorities: IRC §§ 1361(b), 1361(c)(2), 1361(d), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(j)(6)

Full text (IRS public release)

Internal Revenue Service                                          Department of the Treasury
                                                                  Washington, DC 20224

Number: 202430003                                                 Third Party Communication: None
Release Date: 7/26/2024                                           Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.01-00,
               1361.01-02, 1361.03-00,                            Person To Contact:
               1361.03-02, 1362.02-00,                            --------------------, ID No.
               1362.02-02, 1362.04-00                             Telephone Number:
                                                                  --------------------
                                                                  Refer Reply To:
                                                                  CC:PSI:B01
                                                                  PLR-121546-23
                                                                  Date:
                                                                  April 29, 2024




LEGEND

X                          =        -------------------------------
                                    EIN:

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

Original Trust             =

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

                                    EIN: ----------------

Trust 2                    =
                                    ---------------------------
                                    EIN:

Trust 3                    =        ---------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------

                                    EIN: ----------------

Trust 4                    =
                                    ---------------------------
                                    EIN

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

Date 1                     =
PLR-121546-23                                        2


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

Date 3               =

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


Dear            :

        This letter responds to a letter dated October 20, 2023, and subsequent
correspondence, submitted on behalf of X, by X’s authorized representative, requesting
relief under § 1362(f) of the Internal Revenue Code (Code).

                                             FACTS

       According to the information submitted, X was incorporated under the laws of
State on Date 1 and elected to be treated as an S corporation effective Date 2.

       A, an individual and eligible shareholder owned shares of X. During A’s lifetime,
A transferred the shares of X to Original Trust. Original Trust was treated as an eligible
shareholder of X under § 1361(c)(2)(A)(i). On Date 3, A died. Following A’s death,
Original Trust continued to own the shares of X until Date 4, and, therefore, remained
an eligible shareholder of X under § 1361(c)(2)(A)(ii).

       On Date 4, Original Trust transferred all its shares of X to Trust 1, Trust 2, Trust
3, and Trust 4. X represents that each of Trust 1 through Trust 4 satisfy the
requirements of a Qualified Subchapter S Trust (QSST) set forth in § 1361(d)(3)(A).
However, the income beneficiary of each of Trust 1 through Trust 4 failed to make a
valid QSST election. Therefore, each of Trust 1 through Trust 4 became an ineligible
shareholder on Date 4, thereby causing X’s S corporation election to terminate as of
Date 4.

        X represents that X and the beneficiaries of each of Trust 1 through Trust 4
intended that each of the trusts be treated as a QSST and that the inadvertent failure to
make valid QSST elections under § 1361(d)(2) was neither motivated by tax avoidance
or retroactive tax planning nor part of a plan to terminate X’s S corporation election.

        X represents that X has qualified as an S corporation and has been consistently
treated as an S corporation since Date 2. X also represents that the beneficiaries of
Trust 1, Trust 2, Trust 3, and Trust 4 treated each of their respective trusts as QSSTs
effective as of Date 4, received all income (within the meaning of § 643(b)) from the
trust each taxable year, and reported their respective shares of X’s income on their
individual tax returns for all relevant taxable years. Finally, X and its shareholders agree
PLR-121546-23                                 3

to make any adjustments that the Secretary may require as a condition of obtaining
relief under § 1362(f).


                                   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) provides that the term “small business corporation” means 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 of the Code)
as owned by an individual who is a citizen or resident of the United States may be a
shareholder of an S corporation.

       Section 1361(c)(2)(A)(ii) provides that, for purposes of § 1361(b)(1)(B), a trust
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) 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 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 1361(d)(2)(A) provides that a beneficiary of a QSST may elect to have
§ 1361(d) apply. Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary
of a QSST 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 returns the applicable
form or a statement including the information listed in § 1.1361-1(j)(6)(ii).
PLR-121546-23                                 4


        Section 1.1361-1(j)(6)(iii)(A) provides that the QSST election must be made
within the 16-day-and-2 month period beginning on the day that the stock is transferred
to the trust.

        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 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(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, in relevant part, that if (1) an election under § 1362(a)
by any corporation was terminated under § 1362(d)(2); (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 such
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 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 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 representations made, we conclude that
X’s S corporation election terminated on Date 4 because no valid QSST elections were
made for Trust 1, Trust 2, Trust 3, or Trust 4. We further conclude that the termination of
X’s S corporation election on Date 4 was inadvertent within the meaning of § 1362(f).
Accordingly, X will be treated as an S corporation effective Date 4, and thereafter,
provided X’s S corporation election was otherwise valid and was not otherwise
terminated under § 1362(d). Further, Trust 1, Trust 2, Trust 3, and Trust 4 will be treated
as QSSTs from Date 4 and each year thereafter, provided each of the trusts meet the
requirements of § 1361(d)(3)(A) and the beneficiary of each trust is treated, for
purposes of § 678, as the owner of the X shares transferred to its respective trust on
Date 4.
PLR-121546-23                                   5

       This ruling is contingent on the following: (1) the beneficiary of each of Trust 1,
Trust 2, Trust 3, and Trust 4 must file within 120 days of the date of this letter a QSST
election effective Date 4 with the appropriate service center; (2) each of Trust 1, Trust 2,
Trust 3, and Trust 4 must file within 120 days from the date of this letter amended
returns for all years consistent with the requested relief to properly reflect the treatment
of each of Trust 1, Trust 2, Trust 3, and Trust 4 as a QSST; and (3) Trust 1, Trust 2,
Trust 3, and Trust 4 must properly indicate its status as a QSST on all future returns. A
copy of this letter should be attached to the QSST elections and any amended returns.

         Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed or implied concerning the
eligibility of X to be an S corporation or the eligibility of Trust 1, Trust 2, Trust 3, or Trust
4 to be QSSTs.

      This ruling is directed only to the taxpayer requesting it. According to Section
6110(k)(3) of the Code, this ruling may not be used or cited as precedent.

      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 request for rulings, 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 X’s authorized representative.


                                         Sincerely,


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




Enclosure
      Copy for § 6110 purposes
PLR-121546-23                                                6

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