Corporation kept S status after a trust beneficiary missed the QSST election

Plain-English summary

A grantor trust held stock in an S corporation until its deemed owner died. The trust could remain an eligible shareholder for two years after the death, but the income beneficiary failed to make a qualified subchapter S trust election before that period expired. The trust then became an ineligible shareholder and technically terminated the corporation’s S election. The corporation and shareholders continued filing consistently with S corporation treatment, and the IRS found that the termination was inadvertent under IRC § 1362(f). It ruled that the corporation would be treated as continuously maintaining S status and that the trust would be treated as a QSST from the termination date forward. Relief requires the beneficiary to file the QSST election and both the trust and beneficiary to file all required original or amended returns for open years within 120 days.

Ruling snapshot

• Question: Was the corporation’s S election inadvertently terminated when the trust beneficiary missed the QSST election?
• Outcome: Approved
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d), 1362(f); Treas. Reg. § 1.1361-1(j)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202515001
Third Party Communication: None
Release Date: 4/11/2025
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
-------------------------------------------- -------------------------, ID No. -----------------
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Telephone Number:
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---------------------------------------------------------- Refer Reply To:
CC:PT&E:B01
In Re: Private Letter Ruling Request
PLR-111693-24
Date:
January 15, 2025

LEGEND

X = ----------------------------------------------------------------------------------------------
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Trust = ----------------------------------------------------------------------------------------------
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A = ----------------------------------------------------------------------------------------------
---------------------------

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

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

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

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

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

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

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

This letter responds to a letter dated June 19, 2024 submitted on behalf of X by its authorized representatives, requesting relief under § 1362(f) of the Internal Revenue Code (Code).
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FACTS

According to the information submitted and representations within, X was incorporated under the laws of State on Date 1 and filed an election under § 1362(a) of the Code to be treated as an S corporation effective Date 2.

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. On Date 5, A, the income beneficiary of Trust, failed to timely file an election under § 1361(d)(2) for Trust to be a qualified subchapter S trust (QSST). Accordingly, Trust became an ineligible shareholder of X, and X's S corporation status was terminated following the expiration of the two-year period, specified in § 1361(c)(2)(A)(ii), on Date 5.

X represents that Trust met the requirements of a QSST within the meaning of
§ 1361(d)(3) since Date 5. X represents that X and its shareholders have filed tax returns consistent with being an S corporation for all relevant periods. X further represents that the circumstances resulting in the termination of its S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. 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) 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.

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
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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 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)(B)(ii) provides that if a QSST election is made with respect to any beneficiary, an election under this paragraph shall be treated as made by each successive beneficiary unless such beneficiary affirmatively refuses to consent to such election.

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.

Section 1361(d)(3) further provides that 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) and (c).

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 1.1361-1(j)(7)(i) of the Income Taxation 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)(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
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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 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 information submitted and the representations made, we conclude that X's S corporation election terminated on Date 5, when Trust became an ineligible shareholder. We conclude that the circumstances resulting in the termination of X's S corporation election were inadvertent within the meaning of § 1362(f). Accordingly, 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). Furthermore, Trust will be treated as a QSST from Date 5 and thereafter.

This ruling is subject to the following conditions that must occur within one hundred twenty (120) days from the date of this letter: (1) A must file a QSST election, as described under § 1361(d)(2), effective Date 5 with the appropriate service center and (2) both Trust and A must file any original and amended returns for all open taxable years consistent with the relief granted in this letter.

A copy of this letter should be attached to the QSST election and amended returns. Furthermore, if these conditions are not met, X must notify the service center where X's S corporation election is filed that its S corporation election has terminated effective Date 5.

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
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Code. Specifically, we express or imply no opinion regarding whether X is otherwise eligible to be an S corporation or whether Trust is otherwise eligible to be 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 upon examination.

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 copies of this letter to X's authorized representatives.

Sincerely,

By:
Laura Fields
Chief, Branch 1
Office of Associate Chief Counsel
(Passthroughs, Trusts, and Estates)

Enclosure
Copy for § 6110 purposes

cc: