S corporation status preserved after five trusts missed elections

Plain-English summary

Shareholders transferred S corporation stock to five trusts on three different dates. Three trusts qualified to elect as qualified subchapter S trusts, and two qualified to elect as electing small business trusts, but the beneficiaries or trustees did not file the required elections on time. The resulting ineligible shareholders terminated the corporation's S election. The corporation represented that the failures were not motivated by tax avoidance or retroactive tax planning and that everyone had consistently filed as though S status continued. The IRS treated the termination as inadvertent and allowed the corporation to remain an S corporation from the first transfer date forward. Relief was conditioned on filing the three QSST elections and two ESBT elections within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after five shareholder trusts failed to make timely QSST or ESBT elections?
• Outcome: Approved, conditioned on all five trust elections being filed within 120 days.
• Key authorities: IRC §§ 1361(d) and (e), 1362(d), and 1362(f); Treas. Reg. § 1.1361-1(j)(6) and (m)(2)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201824010                                            Third Party Communication: None
Release Date: 6/15/2018                                      Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                             Person To Contact:
-----------------------                                      --------------------------, ID No. ------------
------------------------------------------------------       Telephone Number:
----------------                                             --------------------
-------------------------------------                        Refer Reply To:
                                                             CC:PSI:03
                                                             PLR-133340-17
                                                             Date:
                                                             March 07, 2018



LEGEND

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

State      = --------

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

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

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

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

D5         = ----------------

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

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

Trust3 = ------------------------------------------------------------------------------------------------------------------------
         ---------------

Trust4 = ------------------------------------------------------------------------------------------------------------------------

Trust5 = ------------------------------------------------------------------------------------------------------------------------


Dear ---- --------:
PLR-133340-17                                2

      This letter responds to a letter dated October 30, 2017, and additional
information, submitted on behalf of X by its authorized representative requesting a ruling
under § 1362(f) of the Internal Revenue Code.

                                         FACTS

        X was formed under the laws of State on D1 and elected to be an S corporation
effective D2. On D3, a shareholder transferred shares of X’s outstanding stock to
Trust1 and to Trust2. X represents that Trust1 was eligible to be a qualified subchapter
S trust (QSST) within the meaning of § 1361(d) on D3, but the income beneficiary did
not timely file a QSST election. X also represents that Trust2 was eligible to be an
electing small business trust (ESBT) within the meaning of § 1361(e) on D3, but the
trustee did not timely file an ESBT election. Therefore, neither Trust1 nor Trust2 was a
permitted shareholder and X’s S corporation election terminated on D3.

       On D4, a shareholder transferred shares of X’s outstanding stock to Trust3. X
represents that Trust3 was eligible to be an ESBT within the meaning of § 1361(e) on
D4, but the trustee did not timely file an ESBT election. Therefore, Trust3 was not a
permitted shareholder, and if X’s S corporation election had not terminated on D3, it
would have terminated on D4.

       On D5, a shareholder transferred shares of X’s outstanding stock to Trust4 and
Trust5. X represents that Trust4 and Trust5 were eligible to be QSSTs within the
meaning of § 1361(d) on D5, but the income beneficiaries did not timely file QSST
elections. Therefore, neither Trust4 nor Trust5 was a permitted shareholder, and if X’s S
corporation election had not terminated on D3 or D4, it would have terminated on D5.

       X represents that the terminations were 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
PLR-133340-17                                 3

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(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B) an ESBT
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.

       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 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as
provided in § 1361(e)(1)(B), an ESBT means any trust if (i) such trust does not have as
a beneficiary any person other than (I) an individual, (II) an estate, (III) an organization
described in § 170(c)(2), (3), (4), or (5), or (IV) an organization described in § 170(c)(1)
which holds a contingent interest in such trust and is not a potential current beneficiary,
(ii) no interest in such trust was acquired by purchase, and (iii) an election under
§ 1361(e) applies to such trust. Section 1361(e)(3) provides that an election under
§ 1361(e) shall be made by the trustee.

        Section 1.1361-1(m)(2)(i) provides that the trustee of an ESBT must make the
ESBT election by signing and filing, with the service center where the S corporation files
its income tax return, a statement that meets the requirements of § 1.1361-1(m)(2)(ii).

Section 1362(d)(2)(A) provides that an election under § 1362(a) will be terminated
PLR-133340-17                                 4

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(d)(2)(B) provides that any termination under § 1362(d) 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 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 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), 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.

                                      CONCLUSION

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on D3. 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 D3
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 filing a QSST election
effective D3, and Trust4 and Trust5 filing QSST elections effective D5, 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.
        This ruling is also conditioned on the trustee of Trust2 filing an ESBT election
effective D3, and the trustee of Trust3 filing an ESBT election effective D4, with the
appropriate service center within 120 days of the date of this letter. A copy of this letter
should be attached to the ESBT 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, the
eligibility of Trust1, Trust4, or Trust5 to be a QSST, or the eligibility of Trust2 or Trust3
to be an ESBT.
PLR-133340-17                                5

      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,



                                      James A. Quinn
                                      Senior Counsel, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)

Enclosures (2):

      Copy of this letter
      Copy for § 6110 purposes