An S corporation's accidental termination is forgiven after two trusts missed their QSST elections

Plain-English summary

An S corporation can only have certain kinds of shareholders. A trust generally is not an eligible shareholder unless it fits a permitted category, and one common way is for the trust's income beneficiary to elect "qualified subchapter S trust" (QSST) treatment under section 1361(d). Here an S corporation's shares were transferred to two trusts that were eligible to be QSSTs, but the trusts' beneficiaries inadvertently failed to make timely QSST elections. Because the trusts held the shares without valid elections, the corporation had ineligible shareholders and its S corporation status automatically terminated on the transfer date. The company represented that the failure was inadvertent and not tax-motivated, and that it had continued filing as an S corporation. Section 1362(f) lets the IRS forgive an inadvertent termination and treat the company as having remained an S corporation, provided corrective steps are taken. The IRS ruled the termination was inadvertent and that the company will be treated as continuing to be an S corporation from the termination date, conditioned on both trusts' beneficiaries filing QSST elections effective as of that date within 120 days. This restores the company's pass-through tax status despite the beneficiaries' oversight.

Ruling snapshot

• Question: Was the S corporation's termination (caused by two trusts' missed QSST elections) inadvertent, so the company can be treated as remaining an S corporation under section 1362(f)?
• Outcome: approved (inadvertent termination relief granted, contingent on the beneficiaries filing QSST elections within 120 days)
• Key authorities: IRC §§ 1362(f), 1362(d)(2), 1361(d) (QSST), 1361(c)(2); Treas. Reg. § 1.1361-1(j)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201911005                                              Third Party Communication: None
Release Date: 3/15/2019                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                               Person To Contact:
---------------------------------                              --------------------, ID No. --------------
-------------------------------------------                    Telephone Number:
------------------------------                                 ----------------------
--------------                                                 Refer Reply To:
------------------------------                                 CC:PSI:B03
                                                               PLR-131417-18
                                                               Date:
                                                               December 12, 2018




LEGEND

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

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

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

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

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

Trust 1           =        --------------------------------------------------------------
---------------------------------------------------

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

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

       This responds to a letter dated October 17, 2018, submitted on behalf of X by its
authorized representatives, requesting a ruling under § 1362(f) of the Internal Revenue
Code.

       The information submitted states that X was incorporated under the laws of State
on D1, and elected to be an S corporation effective on D2. On D3, shares of X were
transferred to both Trust 1 and Trust 2 (together, “the Trusts”).
PLR-131417-18                                 2

      X represents that the Trusts were eligible to elect qualified subchapter S trust
(QSST) treatment under § 1361(d). However, the respective beneficiaries of the Trusts
inadvertently failed to timely make QSST elections. Therefore, X’s S election
terminated on D3.

       X represents that X and each of its shareholders have filed consistently with the
treatment of X as an S corporation since D3. X represents that the termination was not
motivated by tax avoidance or retroactive tax planning. 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.

       Section 1361(a)(1) of the Code 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 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 I 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 in the case of a QSST for which a beneficiary
makes an election under § 1361(d)(2), the trust is treated as a trust described in
§ 1361(c)(2)(A)(i), and for purposes of § 678(a), the beneficiary of the trust shall be
treated as the owner of that portion of the trust that 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 may elect to have
§ 1361(d) apply. Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary
of a QSST must make the election under § 1361(d)(2) by signing and filing with the
service center with which the corporation files its income tax returns the applicable form
or a statement including the information listed in § 1.1361-1(j)(6)(ii).

       Section 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall
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, and (B) any termination under § 1362(d)(2) shall be effective on
and after the date of cessation.
PLR-131417-18                                3

        Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any
corporation (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 to obtain shareholder consents or (B) was terminated under § 1362(d)(2)
or (3), (2) the Secretary determines that the circumstances resulting in the
ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of
time after discovery of the circumstances resulting in the ineffectiveness or termination,
steps were taken (A) so that the corporation is a small business corporation or (B) to
acquire the shareholder consents, 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 ineffectiveness or
termination, the corporation will be treated as an S corporation during the period
specified by the Secretary.

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on D3, because of the inadvertent failure of
the respective beneficiaries of the Trusts to make QSST elections, and that this
termination of X’s S election was an inadvertent termination within the meaning of
§ 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as
continuing to be an S corporation from D3 and thereafter, provided X’s S corporation
election was valid and not otherwise terminated under § 1362(d).

       This ruling is contingent upon the respective beneficiaries of each of the two
Trusts filing QSST elections, with an effective date of D3, with the appropriate service
center within 120 days of the date of this ruling. A copy of this letter should be attached
to each of the two the QSST elections. If X or its shareholders fail to treat X as
described above, this letter ruling will be null and void.

       Except as specifically set forth above, no opinion is expressed concerning the
federal tax consequences of the facts described above under any other provision of the
Code, including whether X is a small business corporation under § 1361(b), or whether
the Trusts are QSSTs within the meaning of § 1361(d)(3).

       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-131417-18                                4


        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. Pursuant to a power of attorney
on file, a copy of this letter is being sent to X’s authorized representatives.



                                      Sincerely,



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

Enclosures: 2
      Copy of this letter
      Copy for § 6110 purposes



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