Corporation receives inadvertent S election termination relief

Plain-English summary

Two trusts became shareholders of a parent S corporation after a merger but failed to make new qualified subchapter S trust elections effective on the merger date. That failure terminated the parent corporation's S election. The corporation represented that the mistake was inadvertent, was not motivated by tax avoidance or retroactive planning, and that the corporation, trusts, beneficiaries, and shareholders had consistently filed as though the S election remained valid. The IRS granted relief under IRC § 1362(f) and treated the corporation as continuing to be an S corporation from the merger date. The relief required each trust beneficiary to file the appropriate QSST election within 120 days.

Ruling snapshot

• Question: Can an S corporation receive inadvertent termination relief when two trust shareholders fail to make timely QSST elections after a merger?
• Outcome: Approved, contingent on both beneficiaries filing QSST elections within 120 days
• Key authorities: IRC §§ 1361 and 1362(f)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201618003                                              Third Party Communication: None
Release Date: 4/29/2016                                        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-136770-15
                                                               Date:
                                                               January 27, 2016




LEGEND

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

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

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

Trust1 =           ----------------------------------------------------------------------------
-------------------------------------------

Trust2 =           -----------------------------------------------------------------------------
------------------------------------------

D1       =        ---------------------------

D2       =        ---------------------------

D3       =        -------------------------

D4       =        ----------------------

State1 =          -------------

State2 =          -------

PLR-136770-15                                 2

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

This responds to a letter dated October 30, 2015, 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 and elected to be taxed as
an S corporation on D1, under the laws of State1.

On D2, Trust1 and Trust2 acquired shares of Y, an S corporation. Trust 1 and Trust 2
made timely qualified subchapter S trust (QSST) elections. On D3, X formed Z, as an S
corporation acquisition subsidiary, organized under the laws of State2.

On D4, Z was merged with and into Y, with Y surviving the merger. Each Y shareholder
received shares in X. As a result of the merger, Y became a wholly owned subsidiary of
X and X made an election to treat Y as a qualified S corporation subsidiary. Trust 1 and
Trust 2 failed to make timely QSST elections effective D4, thus causing X’s S
corporation election to terminate.

X represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. X further represents that X and its shareholders have filed their income tax
returns consistent with having a valid S election in effect for all taxable years since X
elected to be an S corporation. X also represents that Trust1 and Trust2, and their
beneficiaries, have filed their tax returns consistent with the trusts qualifying as QSSTs.
X represents that Trust1 and Trust2 are eligible to elect to be treated as QSSTs and
have qualified as QSSTs except for the failure to file a timely election to be treated as
QSSTs.

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.

PLR-136770-15                                 3

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(d)(1) provides that a QSST whose beneficiary makes an election under
paragraph 1361(d)(2) will be treated as a trust described in subsection 1361(c)(2)(A)(i)
and for purposes of section 678(a), the beneficiary of the trust will be treated as the
owner of that portion of the trust that consists of stock in an S corporation with respect
to which the election under paragraph 1362(d)(2) is made.

Section 1361(d)(3) 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 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.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude X’s S
election terminated on D4 when Trust1 and Trust2 became shareholders. We also
conclude that the termination of X’s S corporation election was inadvertent within the
meaning of § 1362(f).

Accordingly, under § 1362(f), X will be treated as continuing to be an S corporation from
D4 and thereafter, provided that X’s S election is valid and not otherwise terminated
under § 1362(d).

PLR-136770-15                                  4


This relief is contingent upon the beneficiaries of Trust1 and Trust2 each filing a QSST
election for their respective trust effective D4 within 120 days from the date of this letter.
A copy of this letter should be attached to the election.

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 the eligibility of X
to be an S corporation or Trust1 and Trust2 to be QSSTs.

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 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: