Late QSST election does not end corporation's S status

Plain-English summary

S corporation stock passed from a grantor retained annuity trust to a successor trust that met the requirements for a qualified subchapter S trust. The successor trust's beneficiary failed to make a timely QSST election, causing the corporation's S election to terminate. The IRS found that the termination was inadvertent and allowed the corporation to continue as an S corporation. Relief required the beneficiary to file the QSST election within 120 days with the effective date of the stock transfer, and the shareholders had to report consistently with continued S corporation status.

Ruling snapshot

• Question: Could the corporation retain S status after a trust beneficiary failed to make a timely QSST election?
• Outcome: Approved as an inadvertent termination, subject to a corrective QSST election within 120 days.
• Key authorities: IRC §§ 1361(d) and 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: 201610003                                              Third Party Communication: None
Release Date: 3/4/2016                                         Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                               Person To Contact:
--------------                                                 ------------------------, ID No. ----------------
----------------------------------------------                 Telephone Number:
------------------------------                                 --------------------
 ----------------------------------------                      Refer Reply To:
                                                               CC:PSI:B3
                                                               PLR-118030-15
                                                               Date:
                                                               November 30, 2015

LEGEND

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

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

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

GRAT              =        --------------------------------------------------

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

State             =        --------

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

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

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

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

       This letter responds to a letter dated May 15, 2015, and subsequent
correspondence, submitted on behalf of X, requesting a ruling under § 1362(f) of the
Internal Revenue Code (Code).

FACTS

       The information submitted states that X was incorporated in State on Date 1 and
elected to be treated as an S corporation effective Date 1. On Date 2, A created GRAT
PLR-118030-15                                 2

and contributed X stock to GRAT. GRAT was treated as a grantor trust under subpart E
of part I of subchapter J of chapter 1 of the Code. On Date 3, GRAT terminated, and X
stock was distributed to Trust, a trust created under the terms of GRAT.

        X represents that Trust satisfied all of the requirements of a qualified subchapter
S trust (“QSST”) within the meaning of § 1361(d)(3). However, B (the income
beneficiary of Trust) failed to timely file a QSST election under § 1361(d)(2)(A). As a
result, X’s S corporation election terminated on Date 3.

        X represents that the termination of X’s S corporation election was not motivated
by tax avoidance or retroactive tax planning. Additionally, X represents that X and its
shareholders have filed their federal income tax returns consistent with having a valid S
corporation election in effect for X for all relevant periods, and that its shareholder has
filed consistent with having a valid QSST election in effect as appropriate. X and its
shareholders have agreed to make any adjustments consistent with the treatment of X
as an S corporation as may be required by the Commissioner with respect to the period
specified by § 1362(f).

LAW

      Section 1362(a) provides that, except as provided in § 1362(g), a small business
corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

        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, in part, that the term “small business corporation”
means a domestic corporation which is not an ineligible corporation and which 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 purposes of § 1361(b)(1)(B), a trust all
of which is treated (under subpart E of part 1 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(d)(1) provides that if a QSST’s beneficiary makes an election
under§ 1361(d)(2), such trust shall be 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 (or his legal
representative) may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that
PLR-118030-15                                 3

an election under § 1362(d)(2) shall be effective up to 15 days and 2 months before the
date of the election.

        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 1 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 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 1 individual who is a citizen or resident of the United States.

       Section 1.1361-1(j)(6)(iii) of the Income Tax Regulations provides that if S
corporation stock is transferred to a trust, 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 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(f) provides, in 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 the termination were inadvertent, (3) no later than a
reasonable period of time after discovery of the circumstances resulting in the
termination, steps were taken (A) so that the corporation is a small business corporation
or (B) to acquire the required shareholder consents, and (4) the corporation and each
person who was a shareholder of the corporation at any time during the period specified
pursuant to § 1362(f), agrees to make such adjustments (consistent with the treatment
of the corporation as an S corporation) as may be required by the Secretary with
respect to such period, then, notwithstanding the circumstances resulting in the
termination, the corporation will 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 3 as a result of the failure of the
beneficiary of Trust to make the election required under § 1361(d)(3)(A). However, we
conclude that the termination on Date 3 was inadvertent within the meaning of
§ 1362(f).
PLR-118030-15                                4

        Accordingly, under § 1362(f), X will be treated as continuing to be an S
corporation on and after Date 3, provided that X’s S corporation election was valid and
not otherwise terminated under § 1362(d), and that B makes the required QSST
election for Trust with an effective date of Date 3. This election must be filed with the
appropriate service center within 120 days from the date of this letter. A copy of this
letter should be attached to the QSST election. If B makes the election as instructed
herein, Trust (as a QSST with B as the beneficiary) shall be treated as owning the stock
of X from Date 3. Accordingly, the shareholders of X must include in income their pro
rata share of the separately stated and nonseparately computed items of X as provided
in § 1366, make an adjustments to basis as provided in § 1367, and take into account
any distributions made by X as provided in § 1368. If X or its shareholders fail to treat X
as described above, this letter ruling will be null and void.

        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 provisions of the
Code. Specifically, we express or imply no opinion as to whether X is otherwise eligible
to be treated as an S corporation, or whether Trust is otherwise a QSST within the
meaning of § 1361(d)(3).

       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.

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

      In accordance with a power of attorney on file with this office, we are sending
copies of this letter to your authorized representatives.

                                      Sincerely,


                                      James A. Quinn
                                      Senior Counsel, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)

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


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