Corporation receives inadvertent S election termination relief

Plain-English summary

An S corporation's trust shareholder was intended to be a qualified subchapter S trust, but the beneficiary did not file a timely QSST election and the trust temporarily failed the current-income-distribution requirement. Those defects made the trust an ineligible shareholder and terminated the corporation's S election. The IRS accepted the representation that the termination was inadvertent and allowed the corporation to remain an S corporation continuously. Relief was conditioned on the beneficiary filing a QSST election effective on the original transfer date within 120 days.

Ruling snapshot

• Question: May a corporation receive inadvertent-termination relief after a trust shareholder failed QSST requirements?
• Outcome: Approved, subject to a QSST election within 120 days
• Key authorities: IRC §§ 1361(d), 1362(d), 1362(f)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201617001                                              Third Party Communication: None
Release Date: 4/22/2016                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                               Person To Contact:
----------------------------------------------------------,    ------------, ID No. ----------------
------------------------------------                           Telephone Number:
-------------------                                            --------------------
 --------------------------------------------                  Refer Reply To:
                                                               CC:PSI:B01
                                                               PLR-125911-15
                                                               Date:
                                                               January 15, 2016

Legend

X                 =         ---------------------------------------
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B                 =         ------------------------------
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Trust             =         -----------------------------------------------------
---------------------------------------------------

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

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

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

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

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

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

       This responds to a letter dated July 28, 2015, submitted on X’s behalf by X’s
authorized representative, requesting relief under § 1362(f) of the Internal Revenue
Code.

FACTS

      According to the information submitted, X was formed under the laws of State on
Date 1 and elected to be treated as an S corporation effective Date 2. Trust was a
shareholder of X as of Date 3.

PLR-125911-15                                 2


      Trust was intended to be a qualified subchapter S trust (QSST). Since Date 3, B
has reported the income, gain, and loss allocated to Trust by reason of Trust’s
ownership of X stock.

       It is represented that Trust possessed the elements of a QSST described in
§ 1361(d)(3)(A). However, Trust did not meet the requirements of § 1361(d)(3)(B). On
Date 4, Trust took corrective action to comply with § 1361(d)(3)(B). Further, B, the
beneficiary of Trust, did not file a timely election to treat Trust as a QSST. Therefore,
Trust was not a permissible shareholder and X’s S corporation election terminated on
Date 3.

       X represents that the terminating event was inadvertent and was not motivated
by tax avoidance or retroactive tax planning. X and its shareholders have agreed to
make such adjustments (consistent with the treatment of X as an S corporation) as 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) 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 § 1361(b)(1)(B), a trust all
of which is 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 may be an S corporation
shareholder.

       Section 1361(d)(1) provides that a QSST whose beneficiary makes an election
under § 1361(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 section 678(a)) of that
portion of the trust which consists of stock in an S corporation with respect 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. Section 1.1361-1(j)(6)(iii) 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.

PLR-125911-15                                  3


         Section 1361(d)(3)(A) defines a QSST as a trust 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 that beneficiary; (iii) the income interest of the
current income beneficiary in the trust shall terminate on the earlier of the 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 the
beneficiary.

        Section 1361(d)(3)(B) further defines a QSST as a trust all of the income 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)(4)(B) provides that if any
QSST ceases to meet any requirement of § 1361(d)(3)(B) but continues to meet the
requirements of § 1361(d)(3)(A), the provisions of § 1361(d) will not apply to the trust as
of the first day of the first taxable year beginning after the first taxable year for which it
failed to meet the requirements of § 1361(d)(3)(B).

      Under § 1362(d)(2), an election to be an S corporation will 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) the corporation ceases to be a small business
corporation.

        Section 1362(f) provides 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 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 such corporation at any time
during the period specified pursuant to 1362(f), agrees to make such 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 termination, such corporation shall be treated as an S
corporation during the period specified by the Secretary.

CONCLUSION

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 3 because the beneficiary of Trust
failed to make a timely QSST election and because the requirements of § 1361(d)(3)(B)
were not met. We further conclude that the termination of X’s S corporation election
was inadvertent within the meaning of § 1362(f). Therefore, X will be treated as

PLR-125911-15                                  4

continuing to be an S corporation on and after Date 3, provided that X’s S corporation
election was otherwise valid and was not otherwise terminated under § 1362(d).

        This ruling is contingent on the beneficiary of Trust filing a QSST election for
Trust effective Date 3, with the appropriate service center within 120 days of the date of
this letter. A copy of this letter should be attached to the election.

         Accordingly, X’s shareholders, in determining their respective income tax
liabilities, must include their pro rata share of the separately stated and nonseparately
computed items of X as provided in § 1366, make any adjustments to stock basis as
provided in § 1367, and take into account distributions made by X as provided by
§ 1368.

       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 on whether X
was or is otherwise eligible to be treated as an S corporation or whether Trust meets the
requirements of a QSST.

      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 your authorized representative.

                                        Sincerely,



                                        Joy C. Spies
                                        Joy C. Spies
                                        Senior Technician Reviewer, Branch 1
                                        Office of the Associate Chief Counsel
                                        Passthroughs and Special Industries


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