S election preserved after trusts miss QSST elections

Plain-English summary

An S corporation shareholder transferred stock to two trusts that were intended to qualify as qualified subchapter S trusts. The trusts' income beneficiaries failed to file the required QSST elections, so the trusts became ineligible shareholders and the corporation's S election terminated. The corporation and its shareholders continued filing consistently with S corporation treatment and represented that the failure was not motivated by tax avoidance or retroactive planning. The IRS found the termination inadvertent and treated the corporation as an S corporation throughout the affected period. Relief was conditioned on both beneficiaries filing QSST elections effective on the original transfer date within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after two trust beneficiaries failed to make timely QSST elections?
• Outcome: approved
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. §§ 1.1361-1(j)(6) and 1.1362-4

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201646002                                              Third Party Communication: None
Release Date: 11/10/2016                                       Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                               Person To Contact:
-----------------------------                                  --------------------------, ID No. --------------
------------------------------------------------------------   Telephone Number:
--                                                             ----------------------
----------------------------------------------                 Refer Reply To:
--------------------------------------------                   CC:PSI:03
                                                               PLR-114258-16
                                                               Date:
                                                               August 15, 2016




LEGEND

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

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

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

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

Shareholder = ----------------------------------------------------------------------------------------------------------------
              -------------------------

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

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

n                  = ----


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

        This letter responds to a letter dated April 27, 2016, submitted on behalf of X by
its authorized representative requesting a ruling under § 1362(f) of the Internal Revenue
Code.
PLR-114258-16                                2


                                         FACTS

       X was incorporated under the laws of State on D1 and elected to be an S
corporation effective D1. On D2, Shareholder transferred n% of X’s outstanding stock
to Trust1, and n% of X’s outstanding stock to Trust2. X represents that Trust1 and
Trust2 each satisfy the qualified subchapter S trust (“QSST”) requirements under
§ 1361(d)(3) and intended to file elections to be treated as QSSTs effective D2.
However, the income beneficiaries of Trust1 and Trust2 failed to file elections to be
QSSTs effective D2. Therefore, neither trust was a permitted shareholder and X’s S
corporation election terminated on D2.

       X represents that the termination was not motivated by tax avoidance or
retroactive tax planning. X further represents that X and its shareholders have filed
consistently with the treatment of X as an S corporation since D2. X and its
shareholders have agreed to make any adjustments that the Commissioner may
require, consistent with the treatment of X as an S corporation.

                                  LAW AND ANALYSIS

      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 that the term “small business corporation” means 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 one 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 1 of subchapter J of Chapter 1) 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 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
beneficiary of such trust shall be treated as the owner (for purposes of § 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) is made.
PLR-114258-16                                 3


       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
an election under § 1361(d)(2) shall be effective up to 15 days and 2 months before the
date of the election.

        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 under § 1361(d)(2) by signing
and filing with the service center where the corporation files its income tax return the
applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

       Section 1362(d)(2)(A) provides that an election under § 1362(a) 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) such corporation ceases to be a small
business corporation.

        Section 1362(f) provides, in relevant 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, 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.

       Section 1.1362-4(b) provides, in relevant part, that for purposes of § 1.1362-4(a),
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 or 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 was inadvertent.

       Section 1.1362-4(d) provides, in part, that the Commissioner may require any
adjustments that are appropriate. In general, the adjustments should be consistent with
the treatment of the corporation as an S corporation during the period specified by the
Commissioner.
PLR-114258-16                                4

                                     CONCLUSION

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on D2. We also conclude that the
circumstances resulting in the termination were inadvertent within the meaning of
§ 1362(f). Accordingly, under § 1362(f), X will be treated as an S corporation from D2
and thereafter, provided X’s S corporation election was otherwise valid and has not
otherwise terminated under § 1362(d).

        This ruling is conditioned on the beneficiaries of Trust1 and Trust2 filing QSST
elections, effective D2, 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 elections.


         Except as specifically ruled above, we express no opinion concerning the federal
tax consequences of the facts described above under any other provisions of the Code.
Specifically, we express no opinion regarding X’s eligibility to be an S corporation or the
eligibility of Trust1 or Trust2 to be a QSST.


      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 a
copy of this letter to X’s authorized representative.


                                      Sincerely,



                                      Bradford Poston
                                      Senior Counsel, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)

Enclosures (2):

       Copy of this letter
       Copy for § 6110 purposes

cc: