Corporation retains S status after two trusts miss QSST elections

Plain-English summary

An S corporation's stock passed through several family trusts after two shareholders transferred stock and later died. Two trusts intended to qualify as qualified subchapter S trusts, but their income beneficiary failed to make timely QSST elections when each trust received stock. Those failures caused the corporation's S election to terminate, although the corporation and its shareholders continued to report consistently as an S corporation. The IRS found both failures inadvertent and ruled that the corporation would continue to be treated as an S corporation from the first termination date. The relief required the beneficiary to file QSST elections for both trusts within 120 days.

Ruling snapshot

• Question: Can a corporation preserve S corporation status after the same beneficiary failed to make timely QSST elections for two trusts that separately received its stock?
• Outcome: approved, subject to filing both QSST elections within 120 days
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. § 1.1361-1(j)(6)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201805009                                             Third Party Communication: None
Release Date: 2/2/2018                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                              Person To Contact:
--------------------------------------------                  ----------------------------, ID No. --------------
----------------------                                        -----------------
-------------------------------------                         Telephone Number:
 --------------------------------                             --------------------
                                                              Refer Reply To:
                                                              CC:PSI:01
                                                              PLR-116952-17
                                                              Date:
                                                              October 30, 2017


Legend

X              =     -----------------------------------------------------------------------------------------------
                     -----------------------------------
State          =     -------------
Date 1         =     ---------------------
Date 2         =     ---------------------
Date 3         =     ---------------------
Date 4         =     -------------------------
Date 5         =     -------------------------
Date 6         =     --------------------------
Date 7         =     ----------------------
A              =     -----------------------
B              =     -----------------------
C              =     -----------------------------------------------------------------------------------------------
                     ------------------------------------
Trust 1        =     ----------------------------------------
Trust 2        =     ----------------------------------------
Trust 3        =     -----------------------------------------------------------------------------------------------
                     -----------------------------------
Trust 4        =     -----------------------------------------------------------------------------------------------
                     -----------------------------------


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

      This responds to a letter dated May 24, 2017, and subsequent correspondence
submitted on behalf of X by X’s authorized representatives, requesting inadvertent
termination relief under § 1362(f) of the Internal Revenue Code.

PLR-116952-17                                2

                                         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 2. On Date 2, A and B
each owned shares of X. On Date 3, A transferred shares of X stock to Trust 1, a
revocable trust treated as a wholly-owned grantor trust under §§ 671 and 676. On Date
3, B transferred shares of X stock to Trust 2, a revocable trust treated as a wholly-
owned grantor trust under §§ 671 and 676.

       On Date 4, A died and Trust 1, pursuant to its terms, transferred its shares of X
to Trust 2.

       On Date 5, B transferred shares of X stock to Trust 3. X represents that Trust 3
intended to be a qualified subchapter S trust (QSST) described in § 1361(d)(3)(A) as of
Date 5 and thereafter. However, C, the income beneficiary, failed to make a QSST
election within the meaning of § 1361(d)(2), thereby causing X’s S corporation election
to terminate on Date 5.

       On Date 6, B died and Trust 2 ceased to be a grantor trust, but continued to
qualify as an eligible S corporation shareholder under § 1361(c)(2)(A)(ii) for the two year
period beginning on the date of B’s death.

       Effective Date 7, Trust 2, pursuant to its terms, transferred its shares of X stock
to Trust 4. X represents that Trust 4 intended to be a qualified subchapter S trust
(QSST) described in § 1361(d)(3)(A) as of Date 7 and thereafter. However, C, the
income beneficiary, failed to make a QSST election within the meaning of § 1361(d)(2),
thereby causing X’s S corporation election to terminate on Date 7.

       X represents that all circumstances resulting in the termination of its S
corporation election were inadvertent and not motivated by tax avoidance. Further,
since Date 5, X and X’s shareholders have continually treated X as an S corporation.
As such, all items of income, gain, loss, and deduction recognized by X since Date 5
have been allocated among the shareholders of X. X and its shareholders agreed to
make such adjustments consistent with the treatment of X as an S corporation as may
be required by the Secretary.

                                          LAW

        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, for purposes of subchapter S, the term
“small business corporation” means a domestic corporation which is not an ineligible

PLR-116952-17                                 3

corporation and which does not 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 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 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
beneficiary of such trust shall be treated as the owner (for purposes of § 678(a)) of that
portion of the trust which consist of stock in an S corporation with respect to which the
election under § 1361(d)(2) is made.

       Section 1.1361-1(j)(6)(ii) 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) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 1st taxable year for which the
corporation is an S corporation) such 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 representations made, we conclude that
X’s S corporation election terminated beginning on Date 5, when the stock in X was
transferred to Trust 3 because a timely QSST election was not filed under § 1361(d)(2).
We conclude that the termination was inadvertent within the meaning of § 1362(f).

PLR-116952-17                                  4

Moreover, had X’s S corporation election not already terminated on Date 5, it would
have terminated on Date 7, when stock was transferred to Trust 4, and a timely QSST
election was not filed for the trust. Similarly, this would have been inadvertent
termination within the meaning of § 1362(f).

       Therefore, we conclude that X will continue to be treated as an S corporation for
the period from Date 5 provided that X’s S corporation election was valid and was not
otherwise terminated under § 1362(d). This ruling is conditioned upon the income
beneficiary of Trust 3, and Trust 4 filing a QSST election for each trust effective upon
the date the trust received shares of X. All elections must be filed with the appropriate
service center within 120 days of the date of this ruling. A copy of this letter should be
attached to each QSST 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, we express or imply no opinion concerning
the tax consequences of any aspect of any transaction or item discussed or referenced
in this letter. Specifically, we express or imply no opinion regarding whether X is
otherwise eligible to be treated as an S corporation or whether Trust 3 and Trust 4 are
eligible to be treated as QSSTs.

        This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent. Pursuant to a power
of attorney on file, a copy of this letter is being sent to X’s authorized representatives.


                                       Sincerely,

                                       Laura C. Fields

                                       Laura C. Fields
                                       Senior Technician Reviewer, Branch 1
                                       (Passthroughs & Special Industries)

Enclosures (2)
 Copy of Letter
 Copy for 6110 purposes


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