S corporation receives relief for ineligible shareholders and a missed QSST election

Plain-English summary

An S corporation's shares were transferred first to an ineligible entity and later held by a trust that failed to make a timely qualified subchapter S trust election. The parties reported consistently with continued S-corporation treatment and represented that neither problem involved tax avoidance or retroactive planning. The IRS found the termination inadvertent under IRC § 1362(f) and allowed continuous S status. Relief was conditioned on the trust beneficiary filing a QSST election within 120 days with the specified effective date.

Ruling snapshot

• Question: Were the S-election defects caused by the ineligible shareholder and missed QSST election inadvertent?
• Outcome: Approved, subject to filing the QSST election within 120 days
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1362-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201634007 Third Party Communication: None
Release Date: 8/19/2016 Date of Communication: Not Applicable
Index Numbers:1362.00-00, 1362.04-00
Person To Contact:
----------------------------------------------- ----------------------, ID No. -----------------
------------------------------------------ Telephone Number:
--------------------------------- -------------------
-------------------------------- Refer Reply To:
CC:PSI:B3
PLR-108060-16
Date:
May 09, 2016

                                                Legend

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

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

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

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

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

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

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

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

Estate = ------------------------------------

State = ------ -----------
PLR-108060-16 2

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

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

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

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

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

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

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

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

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

   This letter responds to a letter dated January 7, 2016, and subsequent

correspondence, submitted on behalf of X by its authorized representatives, requesting
a ruling under § 1362(f) of the Internal Revenue Code (Code).

                                        Facts

    The information submitted states that X was incorporated under the laws of State

on Date 1 and elected to be an S corporation effective Date 1. On Date 2 and Date 3,
shares of X were transferred from A to B, who then transferred the shares to Y, an
ineligible shareholder under § 1361(b)(1). The members of Y are B and C and are
eligible shareholders under § 1361(b)(1). On Date 4, B requested that the shares be
treated as owned directly by B and C.

    On Date 5, D died. Under §1361(c)(2)(A)(iii), Trust was an eligible shareholder

until Date 6, two years after it received the shares of X from Estate pursuant to the
terms of a will. Accordingly, Trust ceased to be eligible shareholder on Date 7. Had X’s
S corporation election not previously terminated, X’s s corporation election would have
terminated on Date 7. X represents that on Date 8 Trust would have qualified as a
qualified subchapter S trust (“QSST”) under § 1361(d), however no QSST election was
filed.

    X represents that there was no tax avoidance or retroactive tax planning involved

in the transfer of shares of B to Y or in the failure of Trust to timely elect to be classified
as a QSST. In addition, X and its shareholders agree to make any adjustments
PLR-108060-16 3

consistent with the treatment of X as an S corporation as may be required by the
Secretary. X also represents that X and all its shareholders have filed consistently with
X being treated as an S corporation. In addition, X represents that all items allocable to
the shares originally acquired by Y were allocated to and reported by B and C, eligible
shareholders. Trust represents that E reported the income, gain, and loss allocated to
Trust by reason of ownership of X stock. X represents that Trust qualified as a QSST
under section 1361(d) from Date 8.

                                  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)(B) provides that the term “small business corporation” means

a domestic corporation that is not an ineligible corporation and that does not, among
other requirements, 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 1362(a)(1) 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(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 of the Code)
as owned by an individual who is a citizen or resident of the United States may be a
shareholder.

   Section 1361(c)(2)(A)(iii) provides that for purposes of § 1361(b)(1)(B), a trust

with respect to stock transferred to it pursuant to the terms of a will, but only for the 2-
year period beginning on the day on which such stock is transferred to it, may be a
shareholder.

   Section 1361(d)(1) provides that in the case of a QSST with respect to which a

beneficiary makes an election under § 1361(d)(2), the trust is 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 may elect to have § 1361(d)(1)
apply.

 Section 1362(d)(2)(A) provides that an election under § 1362(a) is terminated

whenever (at any time on or after the first day of the first taxable year for which the
PLR-108060-16 4

corporation is an S corporation) such corporation ceases to be a small business
corporation. Section 1362(d)(2)(B) provides that any termination under § 1362(d)(2)(A)
is effective on and after the date of cessation.

    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 of the corporation at any time during
the period specified pursuant to § 1362(f), agree to make the adjustments (consistent
with the treatment of the corporation as an S corporation) as may be required by the
Secretary with respect to this period, then, notwithstanding the circumstances resulting
in such termination, the corporation shall be treated as an S corporation during the
period specified by the Secretary.

    Section 1.1362-4(b) provides 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 termination event was
not reasonably within the control of the corporation and 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.

                                   Conclusion

   Based solely on the facts submitted and representations made, we conclude that

X’s S corporation election was terminated on Date 2 and that the termination was
inadvertent within the meaning of § 1362(f). We further conclude that, if X’s S
corporation election was not already terminated, Trust’s failure to make a timely QSST
election would have caused X’s S corporation election to terminate on Date 7.
Consequently, we rule that X will be treated as an S corporation from Date 2 and
thereafter provided that X’s S corporation election was otherwise valid and not
otherwise terminated under § 1362(d).

    This ruling is contingent on the beneficiary (or beneficiary’s representative) of

Trust filing a QSST election for Trust effective Date 8 with the appropriate service center
within 120 days of the date of this letter. A copy of this letter should be attached to the
QSST election.
PLR-108060-16 5

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the facts described above under any other provision of
the Code, including whether Trust is a valid QSST.

   This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

of the Code provides that it may not be used or cited for precedent.

   Pursuant to a power of attorney on file, we are sending a copy of this letter to X’s

authorized representatives.

  The rulings contained in this letter are 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 rulings requested, it is subject to verification on
examination.

                                  Sincerely,



                                  Richard T. Probst
                                  Senior Technician Reviewer, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: