Late trust elections do not end S corporation status

Plain-English summary

Stock in an S corporation was transferred to seven trusts, but the beneficiaries or their guardians did not timely elect qualified subchapter S trust status. The trusts therefore became ineligible shareholders, terminating or potentially terminating the corporation's S election and its subsidiary's QSub status. The IRS found the failures inadvertent and allowed both statuses to continue. Relief required a specified payment, distributions from each trust to its beneficiary, amended trust returns, and late QSST elections within 120 days. If those conditions are not met, the ruling is void and the corporation must report its terminated S election.

Ruling snapshot

• Question: Can the corporation and its subsidiary retain S corporation and QSub status after seven trusts missed QSST elections?
• Outcome: Approved, subject to completing the required payment, distributions, amended returns, and elections within 120 days
• Key authorities: IRC §§ 1361(d) and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201603001 Third Party Communication: None
Release Date: 1/15/2016 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.01-03
Person To Contact:
-------------------------------------- ----------------, ID No. ------------------
---------------------------------------- Telephone Number:
---------------------------------------- ----------------------
-------------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-102151-15
Date:
October 15, 2015

LEGEND

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

Y = ------------------------

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

B = -------------------------------------

C = ------------------------------

D = ----------------------------

E = --------------------------------------

F = ---------------------------

G = --------------------------------

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

Trust 2 = ----------------------------------------------

PLR-102151-15 2

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

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

Trust 5 = ------------------ -----------------------------

Trust 6 = -------------------------------------

Trust 7 = ------------------------------------------

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

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

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

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

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

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

Date 7 = ----------------------------

Date 8 = ---------------------

Year = -------

Years = ---------------

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

$a = -----------------

$b = -----------------

$c = -----------------
PLR-102151-15 3

$d = -----------------

$e = -----------------

$f = -----------------

$g = -----------------

$h = ----------------------------------------------------------------------------

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

This responds to a letter signed December 29, 2014, and supplemental
correspondence, submitted on behalf of X by X’s authorized representative, requesting
relief under § 1362(f) of the Code.

FACTS

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

Effective Date 2, X elected to treat Y as a Qualified Subchapter S Subsidiary (QSub). X
represents that, at all times on and after Date 2, X has owned all of the outstanding
stock of Y. X represents that it has treated Y as a QSub effective Date 2 and thereafter
and that X has filed tax returns for all tax years consistent with the treatment of Y as a
QSub.

On Date 3, X stock was transferred to Trust 1 and Trust 2. On Date 3, an election was
not timely filed by the former guardian of A and the guardian of B, the income
beneficiaries of Trust 1 and Trust 2 respectively, to qualify Trust 1 and Trust 2 as
Qualified Subchapter S Trusts (QSST) thereby causing Trust 1 and Trust 2 to become
ineligible shareholders of X. As a result, X’s S corporation election terminated on Date
3.

On Date 4, Date 5, Date 6, Date 7, and Date 8, X stock was transferred to Trust 3, Trust
4, Trust 5, Trust 6, and Trust 7, respectively. On Date 4, Date 5, Date 6, Date 7 and
Date 8, an election was not timely filed by the guardians of C, D, E, F, and G,
respectively, the income beneficiaries of Trust 3, Trust 4, Trust 5, Trust 6, and Trust 7,
respectively, to qualify Trust 3, Trust 4, Trust 5, Trust 6, and Trust 7 as Qualified
Subchapter S Trusts (QSST) thereby causing Trust 3, Trust 4, Trust 5, Trust 6, and
Trust 7 to become ineligible shareholders of X. As a result, X’s S corporation and QSub
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elections would have terminated on Date 4, Date 5, Date 6, Date 7, and Date 8, if they
had not already terminated on Date 3, or in the case of Date 5, Date 6, Date 7, and
Date 8, on one of the earlier dates.

X represents that Trust 1, Trust 2 Trust 3, Trust 4, Trust 5, Trust 6, and Trust 7
(collectively referred to as the Trusts) were intended to be QSSTs effective Date 3, Date
4, Date 5, Date 6, Date 7, and Date 8, respectively, however timely QSST elections
were not filed.

X represents that the Trusts have qualified as QSSTs under § 1361(d) at all times, since
the date that each trust first acquired stock in X. X represents that Trust 1, Trust 2 Trust
3, Trust 4, Trust 5, Trust 6, and Trust 7 will each make a distribution of $a, $b, $c, $d,
$e, $f, and $g, respectively, to each of the Trusts respective beneficiaries within 120
days of the date of this ruling letter. X represents that the failure to file QSST elections
for the Trusts was discovered in Year.

X represents that the circumstances resulting in the termination of X’s S corporation
election, and the potential later terminations of its S election, were inadvertent and were
not motivated by tax avoidance or retroactive tax planning. X represents that other than
the failure to make valid QSST elections on Date 3, Date 4, Date 5, Date 6, Date 7, and
Date 8, X has qualified as a small business corporation at all times since its election on
Date 2. X further represents that X has filed its income tax returns consistent with
having a valid S election in effect for all taxable years since X elected to be an S
corporation on Date 2. Lastly, X and its shareholders agree to make any adjustments
required as a condition of obtaining relief under the inadvertent termination rule as
provided under § 1362(f) that may be required by the Secretary.

LAW AND ANALYSIS

Section 1361(a) provides that an S corporation is a small business corporation for which
an election under § 1362(a) is in effect.

Section 1361(b)(1) provides that the terms “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 1 class of stock.

Section 1361(b)(3)(A) generally provides that a Qualified subchapter S subsidiary shall
not be treated as a separate corporation and all assets, liabilities, and items of income,
deduction, and credit of a Qualified subchapter S subsidiary shall be treated as assets,
liabilities, and such items (as the case may be) of the S corporation.
PLR-102151-15 5

Section 1361(b)(3)(B) defines a Qualified subchapter S subsidiary as a domestic
corporation which is not an ineligible corporation, if 100 percent of the stock of the
corporation is owned by the S corporation, and the S corporation elects to treat the
corporation as a Qualified subchapter S subsidiary .

Section 1361(c)(2)(A)(i) of the Code provides that for purposes of section 1361(b)(1) a
trust all of which is treated (under subpart E of part I of subchapter J of this chapter) as
owned by an individual who is a citizen or resident of the United States may be an S
corporation shareholder.

Section 1361(d)(1) of the Code provides that in the case of a qualified subchapter S
trust with respect to which a beneficiary makes an election under paragraph 1361(d)(2)
such trust shall be treated as a trust described in subsection 1361(c)(2)(A)(i) and for
purposes of section 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 paragraph 1362(d)(2) is made.

Section 1361(d)(3) of the Code defines the term “qualified subchapter S trust” as a trust
all of the income (within the meaning of section 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. In addition, the terms of the trust must require that (i) during the lifetime
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.

Section 1.1361-3(a) of the Income Tax Regulations prescribes the time and manner for
making an election to be classified as a Qualified subchapter S subsidiary.

Section 1.1361-3(a)(4) provides that an election may be effective up to two months and
15 days prior to the date the election is filed or not more than 12 months after the
election is filed. The proper form for making the election is Form 8869, Qualified
subchapter S Subsidiary Election.

Section 1361-3(a)(6) provides that an extension of time to make a Qualified subchapter
S subsidiary election may be available under procedures applicable under §§ 301.9100-
1 and 301.9100-3.

Section 1362(a)(1) provides that except as provided in subsection (g), a small business
corporation may elect, in accordance with the provisions of this section, to be an S
corporation. Section 1362(a)(2) provides that an election under this subsection shall be
PLR-102151-15 6

valid only if all persons who are shareholders in such corporation on the day on which
such election is made consent to such election.

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 subsection (a) or
section 1361(b)(3)(B)(ii) by any corporation (A) was not effective for the taxable year for
which made (determined without regard to subsection (b)(2)) by reason of a failure to
meet the requirements of section 1361(b) or to obtain shareholder consents, or (B) was
terminated under paragraph (2) or (3) of subsection (d) or section 1361(b)(3)(C); (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 (A) so that the corporation for which the election was made or the
termination occurred is a small business corporation or a qualified subchapter S
subsidiary, as the case may be, or (B) 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 this subsection, agrees to make such adjustments
(consistent with the treatment of such corporation as an S corporation or a qualified
subchapter S subsidiary, as the case may be) 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 or
a qualified subchapter S subsidiary, as the case may be during the period specified by
the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the termination and potential later termination of X’s S election was inadvertent within
the meaning of § 1362(f). Therefore, X will be treated as an S corporation effective
Date 3 and thereafter, provided X’s S corporation election is not otherwise terminated
under § 1362(d).

This letter ruling is subject to the following conditions: (1) As an adjustment under
§ 1362(f)(4), a payment of $h and a copy of this letter must be sent to the following
address: Internal Revenue Service, Cincinnati Service Center, 201 West Rivercenter
Blvd., Covington, KY 41011, Stop 31, Terri Lackey, Manual Deposit. This payment
must be sent no later than 120 days from the date of this letter; (2) the trustee of Trust
1, Trust 2 Trust 3, Trust 4, Trust 5, Trust 6, and Trust 7 will each make a distribution of
$a, $b, $c, $d, $e, $f, and $g, respectively, to each of the Trust’s respective
PLR-102151-15 7

beneficiaries; (3) the Trusts amending their income tax returns for Years within 120
days of the date of this letter; and (4) upon the beneficiaries, or the guardian of the
beneficiaries, of Trust 1, Trust 2 Trust 3, Trust 4, Trust 5, Trust 6, and Trust 7 each filing
a QSST election under section 1361(d)(2)(A) for their respective trust with an effective
date of Date 3, Date 4, Date 5, Date 6, Date 7, and Date 8, respectively. Both A and
the former guardian of A should sign the QSST election for Trust 1. These elections
should be made with the appropriate service center within 120 days from the date of this
letter. A copy of this letter should be attached to the election. If these conditions are
not met, then this ruling is null and void. Furthermore, if these conditions are not met, X
must send notification that its S election has terminated to the service center with which
X’s S election was filed.

Furthermore, Y will be treated as a QSub effective Date 2 and thereafter, provided Y
otherwise is eligible to be treated as a QSub.

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 whether X
otherwise qualifies as an S corporation, or whether Y is eligible to be a QSub, for
federal tax purposes.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to the taxpayer’s authorized representatives.

                                    Sincerely,


                                    David R. Haglund
                                    David R. Haglund
                                    Branch Chief, Branch 1
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy of this letter for section 6110 purposes