S corporation receives relief for six late trust elections

Plain-English summary

After a shareholder died, shares of an S corporation passed to six trusts. The trusts were intended to become qualified subchapter S trusts, but their beneficiaries did not timely file the required QSST elections, causing the corporation's S election to terminate. The IRS found the termination inadvertent and agreed to treat the corporation as continuously eligible. Each beneficiary had 120 days to file a QSST election effective on the termination date, and the corporation's two subsidiaries would continue to be treated as qualified subchapter S subsidiaries if otherwise eligible.

Ruling snapshot

• Question: Could the corporation retain continuous S status after six beneficiaries missed their QSST election deadlines?
• Outcome: Approved, conditioned on filing all six QSST elections within 120 days.
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. §§ 1.1361-1 and 1.1362-4

Full text (IRS public release)

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Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201610012 Third Party Communication: None
Release Date: 3/4/2016 Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.03-02
Person To Contact:
---------------------------------- ------------------, ID No. ----------------
------------------------------------------ Telephone Number:
------------------ --------------------
------------------------------------ Refer Reply To:
CC:PSI:B01
PLR-125262-15
Date:
December 02, 2015

LEGEND

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

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

Z = ---------------------------------------------

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

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

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

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

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

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

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

PLR-125262-15 2

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

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

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

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

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

State = --------

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

This responds to a letter dated July 10, 2015, and supplemental information, submitted
on behalf of X, requesting inadvertent termination relief pursuant to § 1362(f) of the
Internal Revenue Code (the Code).

FACTS

According to the information submitted, X was incorporated on Date 1, under the laws of
State. Effective Date 2, X elected to be taxed as an S corporation. Effective Date 3, X
elected to treat both Y and Z as a Qualified Subchapter S Subsidiary (QSub).

On Date 4, A, a shareholder of X, died. Pursuant to A’s will, A’s X shares were
transferred to Trust 1, Trust 2, Trust 3, Trust 4, Trust 5 and Trust 6. Trust 1, Trust 2,
Trust 3, Trust 4, Trust 5 and Trust 6 are collectively referred to as the Trusts. The
Trusts were eligible shareholders of X until Date 5.

As of Date 5, the Trusts were intended to be treated as qualified subchapter S trusts
(QSSTs), however, none of the income beneficiaries of Trust 1, Trust 2, Trust 3, Trust 4,
Trust 5 or Trust 6 filed a timely QSST election for their respective trust, therefore
causing X’s S corporation election to terminate as of Date 5.

X represents that the Trusts qualified as QSSTs under § 1361(d) as of Date 5 and
thereafter. X further represents that the circumstances resulting in the failure to file
QSST elections for the Trusts were inadvertent and were not motivated by tax
avoidance or retroactive tax planning. X further represents that X has filed its income
tax return consistent with having a valid S election in effect for all taxable years since X
elected to be an S corporation. X and its shareholders have agreed to make such
adjustments (consistent with the treatment of X as an S corporation) as may be required
PLR-125262-15 3

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 the year.

Section 1361(b)(1) defines a “small business corporation” as 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(c)(2)(A)(i) 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) as owned by an individual
who is a citizen or resident of the United States may be an S corporation shareholder.

Section 1361(c)(2)(B)(i) provides that for purposes of § 1361(b)(1), in the case of a trust
described in § 1361(c)(2)(A)(i), the deemed owner shall be treated as the 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)(A), a beneficiary of a QSST may elect to have § 1361(d) apply. 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.

Section 1361(d)(4)(B) provides that if any QSST ceases to meet the requirement of §
1361(d)(3)(B), but continues to meet the requirements of § 1361(d)(3)(A), the provisions
of § 1361(d) shall not apply to the trust as of the first day of the first taxable year
PLR-125262-15 4

beginning after the first taxable year for which the trust failed to meet the requirements
of § 1361(d)(3)(B).

Section 1.1361-1)j)(6)(iii)(c) provides that, in the case of a QSST election, if a trust
ceases to be a qualified Subpart E trust, satisfies the requirements of a QSST, and
intends to become a QSST, the QSST election must be filed within the 16-day-and-2-
month period beginning on the date on which the trust ceases to be a qualified subpart
E trust.

Section 1362(a) provides, in part, that a small business corporation may elect to be an
S corporation.

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 part that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d), (2) the Secretary determines that the
circumstances resulting in the termination were inadvertent, (3) no later than a
reasonable period of time after the discovery of the circumstances resulting in the
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 of inadvertent termination of the S election, agrees to makes 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 is treated as an S corporation
during the period specified by the Secretary.

Section 1.1361-1(j)(6)(ii) of the Income Tax Regulations, provides that the current
income beneficiary of the trust must make the election by signing and filing with the
service center with which the corporation files its income tax the applicable form or a
statement including the information listed in § 1.1361-1(j)(6)(ii).

Section 1.1361-1(j)(6)(iii)(A) 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 1.1361-1(j)(6)(iii)(E) provides that if a corporation’s S election terminates
because of a late QSST election, the corporation may request inadvertent termination
relief under § 1362(f).
PLR-125262-15 5

Section 1.1361-1(j)(7)(i) 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 1.1362-4(b) provides, in relevant part, that the determination of whether a
termination was inadvertent is made by the Commissioner. The corporation has the
burden of establishing that under the relevant facts and circumstances the
Commissioner should determine that the termination was inadvertent. The fact that the
terminating event was not reasonably within the control of the corporation and, in the
case of a termination, was not part of a plan to terminate the election, or the fact that the
terminating event or circumstance took place without the knowledge of the corporation,
notwithstanding its due diligence to safeguard itself against such an event or
circumstance, tends to establish that the termination of the election was inadvertent.

Section 1.1362-4(f) provides, in relevant part, that the status of the corporation after the
terminating event and before the determination of inadvertence is determined by the
Commissioner. Inadvertent termination relief may be granted retroactively for all years
for which the terminating event is effective, in which case the corporation is treated as if
its election had not terminated.

Section 1.1362-4(d) provides that the Commissioner may require any adjustments that
are appropriate. In general, the adjustments required should be consistent with the
treatment of the corporation as an S corporation during the period specified by the
Commissioner.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on Date 5 as a result of the failure to make a
timely QSST election for Trust. We further conclude that the termination of X’s S
election on Date 5 was inadvertent within the meaning of § 1362(f).

Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation as of Date 5 and thereafter, provided that the beneficiary of Trust 1, Trust 2,
Trust 3, Trust 4, Trust 5 and Trust 6 each files a QSST election for their respective trust
with an effective date of Date 5 with the appropriate service center within 120 days from
the date of this letter, and X’s S corporation election is not otherwise terminated under
§ 1362(d). A copy of this letter must be attached to the QSST election.

Furthermore, Y and Z will be treated as QSubs effective Date 5 and thereafter, provided
Y and Z otherwise are eligible to be treated as QSubs.

Except as specifically ruled upon above, we express or imply no opinion concerning the
PLR-125262-15 6

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. Further, no opinion is expressed or implied concerning whether Trust
meets the requirements of a QSST under § 1361(d)(3). In addition, we express or imply
no opinion concerning whether Y or Z are eligible to be QSubs.

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.

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 representative.

                                    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

cc:
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