Wrong trust election is treated as an inadvertent S termination

Plain-English summary

An S corporation transferred stock to a trust that was intended and treated as an electing small business trust. The trustee inadvertently filed a qualified subchapter S trust election instead, even though the trust did not operate as a QSST. That mistake made the trust an ineligible shareholder and technically terminated the S election. The IRS found the termination inadvertent and allowed S status to continue if the trustee filed a retroactive ESBT election within 120 days and all parties maintained consistent tax treatment. Otherwise, the relief would be null and void.

Ruling snapshot

• Question: Does the mistaken QSST filing qualify for inadvertent S-election termination relief?
• Outcome: approved
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, 1368; Treas. Reg. § 1.1362-4(d)

Full text (IRS public release)

Internal Revenue Service                                         Department of the Treasury
                                                                 Washington, DC 20224

Number: 201742003                                                Third Party Communication: None
Release Date: 10/20/2017                                         Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                                 Person To Contact:
---------------------------------                                -----------------------, ID No. -------------------
-------------------------------------                            ---------------------------------------------------
-------------------------                                        Telephone Number:
----------------------------------------                         ----------------------
                                                                 Refer Reply To:
                                                                 CC:PSI:B01
                                                                 PLR-102636-17
                                                                 Date:
                                                                 June 19, 2017

Legend

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

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

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

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

Date1 =           ---------------------------

Date2 =           ---------------------------

Date3 =           ----------------------

Date4 =           --------------------

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

This responds to a letter dated January 12, 2017, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under §
1362(f) of the Internal Revenue Code (the Code).

                                                     FACTS

According to the information submitted, X was incorporated under the laws of State on
Date1. X elected to be treated as an S corporation effective Date1. On Date2, stock in
X was transferred to Trust. A, the trustee of Trust, and X intended to treat and have
always treated Trust as an Electing Small Business Trust (ESBT). However, an election
to treat Trust as a Qualified Subchapter S Trust (QSST) effective Date3 was
PLR-102636-17                                 2

inadvertently filed on Date4. Trust did not act as a QSST. Consequently, Trust was an
ineligible shareholder, and, as a result, X’s S corporation election terminated on Date2.

X represents that the circumstances resulting in the termination of its S corporation
election were inadvertent and not motivated by tax avoidance or retroactive tax
planning. Additionally, X and its shareholders have filed their federal income tax returns
consistent with having a valid S corporation election in effect. X and its shareholders
have agreed to make any adjustment consistent with the treatment of X as an S
corporation as may be required by the Secretary with respect to the period specified by
§ 1362(f).
                                  LAW AND ANALYSIS

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which
an election under § 1362(a) is in effect for the taxable 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 I 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(c)(2)(A)(v) provides that, for purposes of § 1362(b)(1)(B), an ESBT is a
permitted shareholder of a small business corporation.

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), such trust shall be 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 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 1362(f) provides, in part, that if (1) an election under § 1362(a) was not effective
for the taxable year for which made (determined without regard to § 1362(b)(2)) by
reason of a failure to meet the requirements of § 1361(b) or (B) was terminated under §
1362(d)(2) or (3); (2) the Secretary determines that the circumstances resulting in such
ineffectiveness or termination were inadvertent; (3) no later than a reasonable period of
PLR-102636-17                                3

time after discovery of the circumstances resulting in such ineffectiveness or
termination, steps were taken 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 such ineffectiveness or termination, the corporation shall be
treated as an S corporation during the period specified by the Secretary.

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. In the case of stock held by an ineligible shareholder that causes an
inadvertent termination or invalid election for an S corporation under § 1362(f), the
Commissioner may require the ineligible shareholder to be treated as a shareholder of
the S corporation during the period the ineligible shareholder actually held stock in the
corporation. Moreover, the Commissioner may require protective adjustments that
prevent the loss of any revenue due to the holding of stock by an ineligible shareholder
(for example, a nonresident alien).
                                      CONCLUSION

Based solely on the information submitted and the representations made, we conclude
that X’s S election terminated on Date2 when Trust became a shareholder, and that the
termination was inadvertent within the meaning of § 1362(f). Therefore, X will be
treated as continuing to be an S corporation from Date2, and thereafter, provided that
X’s S corporation election was otherwise valid and was not otherwise terminated under
§ 1362(d).

This ruling is contingent upon X and all of its shareholders treated X as having been and
S corporation, and Trust as having been an ESBT, for the period beginning Date2, and
thereafter. Within 120 days from the date of this letter, the trustee of Trust must file an
election to treat Trust as an ESBT, effective Date2, with the appropriate service center.
A copy of this letter should be attached to the election. If these conditions are not met,
then this ruling is null and void.

Accordingly, X’s shareholders, in determining their respective income tax liabilities, must
include their pro rata share of the separately and non-separately 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 express concerning whether X is otherwise eligible
to be treated as an S corporation or whether Trust is eligible to be treated as an ESBT.
PLR-102636-17                                  4

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 your authorized representative.

                                       Sincerely,

                                       Laura C. Fields

                                       Laura C. Fields
                                       Senior Technician Reviewer, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

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