Corporation keeps S status after stock transfers to ineligible trusts

Plain-English summary

An S corporation transferred shares to seven trusts whose beneficiaries timely attempted to elect qualified Subchapter S trust status. The trust terms nevertheless allowed income accumulation and distributions to multiple beneficiaries, so the trusts were not eligible S corporation shareholders and the corporation's S election terminated. The trusts were later amended to require current income distributions to one beneficiary each. The IRS found the termination inadvertent and ruled that the corporation would continue to be treated as an S corporation. The relief is conditioned on each beneficiary filing a QSST election effective as of the original transfer date within 120 days.

Ruling snapshot

• Question: Can the corporation retain S status after shares were transferred to trusts that did not initially satisfy the QSST requirements?
• Outcome: Approved. The termination was inadvertent, subject to timely corrective QSST elections and any required adjustments.
• Key authorities: IRC §§ 1361(a), 1361(b), 1361(c), 1361(d), 1362(d), 1362(f).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202516002
Third Party Communication: None
Release Date: 4/18/2025
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-112728-24
Date:
January 10, 2025

Legend

X = -----------------------------
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Trust 1 = ----------------------------------------------------
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Trust 2 = ----------------------------------------------------
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Trust 3 = ----------------------------------------------------
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Trust 4 = ----------------------------------------------------
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Trust 5 = ----------------------------------------------------
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PLR-112728-24
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Trust 6 = ----------------------------------------------------
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Trust 7 = ----------------------------------------------------
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Date 1
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Date 2
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Date 3
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State
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Dear ----------------:

This letter responds to a letter dated June 12, 2024, and subsequent correspondence, 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 and elected to be an S corporation effective Date 1. On Date 2, shares of X stock were transferred to each of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6, and Trust 7 (collectively, the Trusts). The provisions of each Trust were substantially identical, other than the designated beneficiaries. The beneficiary of each Trust made a timely election to treat each of the respective Trusts as a qualified Subchapter S Trust (QSST) under section 1361(d) of the Code, effective Date 2. However, the terms of each of the Trusts on Date 2 permitted the trustee to accumulate net income, and in addition granted the trustee discretion to distribute net income and principal to multiple beneficiaries. Due to one or more of these provisions, X later concluded that the Trusts were not eligible QSSTs and were therefore ineligible S corporation shareholders, causing X's S corporation election to terminate on Date 2. On Date 3, the terms of each of the Trusts were amended to require the distribution of all net income (and in the discretion of the trustee, principal) to a single beneficiary during their lifetime.
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X 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 also represents that X and its shareholders have filed all returns consistent with X’s status as an S corporation, and that each of the Trusts has filed all returns consistent with having been a QSST since Date 2. X and each shareholder agree to make any adjustments required by the Secretary 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 that is not an ineligible corporation and that 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) 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 a QSST whose beneficiary makes an election under § 1362(d)(2) will be treated as a trust described in § 1361(c)(2)(A)(i), and the QSST's beneficiary will be treated as the owner (for purposes of § 678(a)) of that portion of the QSST's S corporation stock to which the election under § 1361(d)(2) applies. Under § 1361(d)(2)(D), this election will be effective up to 15 days and two months before the date of the election.

Section 1361(d)(3) provides that for purposes of § 1361(d), 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 1 income beneficiary of the trust; (ii) any corpus distributed during the life of the current 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 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 1 individual who is a citizen or resident of the United States.
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Section 1362(d)(2)(A) provides that an election under § 1362(a) shall 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); (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 the corporation at any time during the period specified pursuant to § 1362(f), agrees to make any adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the circumstances resulting in the 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 shares of X stock were transferred to the Trusts, which were ineligible S corporation shareholders. We further conclude that the circumstances resulting in the termination of X's S corporation election were inadvertent within the meaning of § 1362(f). Accordingly, 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 has not otherwise terminated under § 1362(d) for reasons not addressed in this letter.

This ruling is contingent on the beneficiary of each of the Trusts filing a QSST election effective Date 2 for each of their respective Trusts with the appropriate service center within one hundred-twenty (120) days from the date of this letter. A copy of this letter should be attached to each QSST election.

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 or the Trusts’ eligibility to be QSSTs.

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 requested ruling, it is subject to verification on examination.
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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.

Pursuant to a power of attorney on file with this office, we are sending a copy of this letter to your authorized representatives.

Sincerely,

/s/

Richard T. Probst
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosure:
Copy of this letter for § 6110 purposes

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