Inadvertent S-corp termination relief where trusts missed their ESBT and QSST elections

Plain-English summary

An S corporation's stock passed through a chain of trusts after a shareholder died. His grantor trust could stay an eligible S-corporation shareholder for only two years after his death. Before that window closed, the stock moved to a second trust that qualified to be an electing small business trust (ESBT), but the trustee never filed the ESBT election on time, which silently terminated the company's S-corporation status. The stock later moved to a third trust that qualified as a qualified subchapter S trust (QSST), but that beneficiary also missed the QSST election, a second event that would have ended S status if it were not already gone. The company kept filing as an S corporation and asked the IRS for relief under section 1362(f), which lets the IRS forgive an S-election termination that was inadvertent and not tax-motivated. The IRS agreed both failures were inadvertent and ruled the company will be treated as an S corporation continuously from the first missed election, on condition the trustee and beneficiary file the late ESBT and QSST elections within 120 days. This is the routine cure for the common trap where a trust holding S-corp stock forgets the special election that keeps the corporation's S status alive.

Ruling snapshot

• Question: Were the terminations of the company's S-corporation election, caused by two trusts failing to make timely ESBT and QSST elections, inadvertent so that S status can be restored under section 1362(f)?
• Outcome: approved (inadvertent-termination relief granted, conditioned on late elections filed within 120 days)
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1361(e), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1

Full text (IRS public release)

Internal Revenue Service                                    Department of the Treasury
                                                            Washington, DC 20224

Number: 201909005                                           Third Party Communication: None
Release Date: 3/1/2019                                      Date of Communication: Not Applicable
Index Numbers: 1361.03-02, 1361.03-03,
              1362.04-00                                    Person To Contact:
                                                            --------------------, ID No. ----------------
-------------------------------------------                 Telephone Number:
--------------------------------------                      --------------------
--------------------------------                            Refer Reply To:
-----------------------------------------                   CC:PSI:B03
----------------------------------------------              PLR-118647-18
                                                            Date:
                                                            November 30, 2018




LEGEND

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

Trust 1 ---------------------------------------------------------------------------
--------------------------------------

Trust 2 = -----------------------------------------------------------------------------------------------------

Trust 3 = -----------------------------------------------------------------------------------------------------
--------------------------------------------
-------------------------------------

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

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

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

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

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

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

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

A           = ----------------------------
----------------------------------------
PLR-118647-18                                           2



a          = -----------------------------------------------


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

This responds to a letter dated January 24, 2018, and subsequent correspondence
submitted on behalf of X, requesting inadvertent termination relief under § 1362(f) of the
Internal Revenue 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 2.

On Date 3, A transferred a shares of X stock to Trust 1. X represents that Trust 1 was
treated as a wholly-owned grantor trust under §§ 671 and 676.

On Date 4, A died and Trust 1 ceased to be a grantor trust with respect to A’ s interests,
but would have continued to qualify as an eligible S corporation shareholder under
§ 1361(c)(2)(A)(ii) for the two year period beginning on the day of the deemed owner’s
death.

On Date 5, before the end of the two year period, Trust 1 transferred a shares of X
stock to Trust 2. X represents that Trust 2 qualified to elect to be treated as an electing
small business trust (ESBT), however, the trustee failed to make a timely ESBT election
within the meaning of § 1361(e)(1)(A)(v) thereby causing X’s S corporation election to
terminate on Date 5.

On Date 6, Trust 2 distributed a shares of stock in X to Trust 3. X represents that
Trust 3 qualified to elect to be treated as a qualified subchapter S trust (QSST) but the
beneficiary failed to make a timely QSST election within the meaning of § 1361(d)(2).
The failure to make the QSST election Date 6, would have terminated X’s S corporation
election had it not already been terminated Date 5.

X represents that the circumstances resulting in the termination of their respective S
corporation elections were inadvertent and not motivated by tax avoidance. X further
represent that it filed returns consistent with its status as an S corporation. X and its
shareholders agree to make such adjustments (consistent with the treatment of X as an
S corporation) as may be required by the Secretary.
PLR-118647-18                                3


                                 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, for purposes of subchapter S, the term “small
business corporation” means a domestic corporation which is not an ineligible
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(c)(2)(A)(ii) and § 1.1361-1(b)(1)(ii) provide that, for purposes of
§ 1361(b)(1)(B), a trust that is described in § 1361(c)(2)(A)(i) immediately before the
death of the deemed owner and that continues in existence after such death is a
permitted S corporation shareholder, but only for the two-year period beginning on the
day of the deemed owner’s death. Section 1.1361-1(h)(3)(i)(B) provides that if stock is
held by a trust described in § 1.1361-1(h)(1)(ii), the estate of the deemed owner is
generally treated as the shareholder as of the day of the deemed owner’s death.

Section 1361(c)(2)(A)(v) provides that for the purposes of § 1362(b)(1)(B), an ESBT
may be a shareholder.

Section 1361(d)(1) provides, in part, that in the case of a QSST with respect to which a
beneficiary makes an election under § 1361(d)(2)(A) such trust shall be treated as a
trust described in § 1361(c)(2)(A)(i).

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
PLR-118647-18                                4

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 2, because the trustee of Trust 2 failed to timely file the ESBT
election under § 1361(e)(1)(A)(v). We conclude that the termination was inadvertent
within the meaning of § 1362(f). Moreover, had X’s S corporation election not already
terminated on Date 5, it would have terminated on Date 6, when stock was transferred
to Trust 3 and the beneficiary of Trust 3 failed to a timely file QSST election under
§ 1361(d)(2). Similarly, this termination was inadvertent within the meaning of
§ 1362(f).

Pursuant to the provisions of § 1362(f), X will be treated as an S corporation on and
after Date 5, unless X’s S corporation election is otherwise terminated under § 1362(d).
This ruling is conditioned on (1) the trustee of Trust 2 filing an ESBT election effective
Date 5, with the appropriate service center within 120 days of the date of this letter, and
2) the beneficiary of Trust 2 filing a QSST election for Trust 2 effective Date 6, within
120 days from the date of this letter. A copy of this letter should be attached the ESBT
and QSST elections.

Specifically, we express or imply no opinion regarding whether X is otherwise eligible to
be treated as an S corporation or whether Trust 2 is eligible to be treated as an ESBT or
whether Trust 3 is eligible to be treated as a QSST.

This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.
PLR-118647-18                                5

In accordance with a power of attorney on file with this office, we are sending a copy of
this letter ruling to your authorized representatives.

                                            Sincerely,



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



Enclosures: Copy of this letter
            Copy of this letter for § 6110 purposes


cc: