S election restored after stock passed to two trusts that were later reformed into QSSTs

Plain-English summary

An S corporation's shares were transferred to two trusts that, as written,
did not qualify as eligible S corporation shareholders, which automatically
terminated the company's S election. The intent had always been for both
trusts to be qualified subchapter S trusts (QSSTs), a type of trust that can
hold S corporation stock, and a state probate court later entered orders
amending both trusts to meet the QSST requirements. The company asked the
IRS for inadvertent-termination relief under Section 1362(f). The IRS agreed
the termination was inadvertent and ruled the company continues to be an S
corporation from the date of the disqualifying transfer. The ruling notes
that under Rev. Rul. 93-79 a court order reforming a trust into a valid QSST
is recognized only prospectively, and it expresses no opinion on whether the
trusts actually qualify as QSSTs. Families that move S corporation stock into
trusts care because a trust that is not drafted correctly can quietly end the
company's S status until it is fixed.

Ruling snapshot

• Question: Was the S election's termination (stock transferred to two not-yet-qualifying trusts, later reformed into QSSTs) inadvertent and curable under § 1362(f)?
• Outcome: Approved (inadvertent termination relief; S status continues from the termination date)
• Key authorities: IRC § 1362(f); IRC § 1361(d) (QSST rules); Rev. Rul. 93-79

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201918003 Third Party Communication: None
Release Date: 5/3/2019 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.02-02,
1362.04-00 Person To Contact:
----------, ID No. ----------
---------- Telephone Number:
---------- ----------
---------- Refer Reply To:
---------- CC:PSI:B01
PLR-118599-18
Date:
November 20, 2018

     Legend

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

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

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

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

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

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

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

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

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

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

   This letter responds to a letter dated May 31, 2018, submitted on X’s behalf by

X’s authorized representative, requesting relief under section 1362(f) of the Internal
Revenue Code (the Code).
PLR-118599-18 2

                                      Facts

   According to the information submitted and representations within such

submission, X was incorporated on Date 1, under the laws of State. In addition, X made
an election to be taxed as an S corporation as of the same date.

    On Date 2, shares in X were transferred to Trust 1. At that time, Trust 1, by the

terms of its governing documents, did not qualify as an eligible S corporation
shareholder. Thus, X’s S corporation election terminated on Date 2, when X stock was
transferred to Trust 1, an ineligible S corporation shareholder. Furthermore, on Date 3,
shares in X were transferred to Trust 2. At that time, Trust 2, by the terms of its
governing documents, did not qualify as an eligible S corporation shareholder. X
represents that it was always the intent to have both Trust 1 and Trust 2 qualify as
qualified subchapter S trusts (QSSTs).

   On Date 4, State probate court entered an order approving amendments to Trust

1 to qualify Trust 1 as a valid qualified subchapter S trust (QSST). On Date 5, State
probate court entered an order approving amendments to Trust 2 to qualify Trust 2 as a
valid QSST.

   X represents that the termination of X’s S corporation election was inadvertent

and was not motivated by a tax avoidance motive or retroactive tax planning. Lastly, X
represents that X and its shareholders agree to make any adjustments consistent with
the treatment of X as an S corporation as may be required by the Secretary.

                                Law and Analysis

   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 section 1362(a) is in effect for such year.

   Section 1361(b)(1) defines a “small business corporation” as 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 section 1361(c)(2), or an organization described in section 1361(c)(6))
who is not an individual, (C) have a nonresident alien as a shareholder, and (D) have
more than 1 class of stock.

   Section 1361(d)(1) provides that a qualified subchapter S trust (QSST) whose

beneficiary makes an election under 1362(d)(2) will be treated as a trust described in
1361(c)(2)(a)(i), and the QSST’s beneficiary will be treated as the owner (for purposes
of section 678(a)) of that portion of the QSST’s S corporation stock to which the election
under 1361(d)(2) applies. Under section 1361(d)(2)(A), a beneficiary of a QSST may
PLR-118599-18 3

elect to have section 1361(d) apply. Under section 1361(d)(2)(D), the election will be
effective up to 15 days and two months before the date of the election.

    Section 1361(d)(3) provides that for purposes of section 1361(d), the term

“qualified subchapter S trust” means a trust (A) the terms of which require that – (i)
during the life of the current income beneficiary, there shall be only one income
beneficiary of the trust; (ii) any corpus distributed during the life of the current
beneficiary may be distributed only to such beneficiary; (iii) the income interest of the
current income beneficiary in the trust shall terminate on the earlier of such beneficiary’s
death or the termination of the trust; and (iv) upon termination of the trust during the life
of the current income beneficiary, the trust shall distribute all of its assets to that
beneficiary; and (B) all of the income (within the meaning of section 643(b)) of which is
distributed (or required to be distributed) currently to one individual who is a citizen or
resident of the United States.

   Section 1.1361-1(j)(6)(ii) of the Income Taxation Regulations provides that the

current income beneficiary of the trust must make the election by signing and filing with
the service center with which the corporation files its income tax return the applicable
form or a statement including the information listed in section 1.1361-1(j)(6)(ii).

  Section 1362(d)(2)(A) provides that an election under section 1362(a) shall be

terminated whenever (at any time on or after 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, in relevant part, that if (1) an election under section

1362(a) by any corporation was terminated under section 1362(d)(2); (2) the Secretary
determines that the circumstances resulting in 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 section 1362(f), agrees to make the 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 ineffectiveness or termination, such corporation shall be
treated as an S corporation during the period specified by the Secretary.

    Rev. Rul. 93-79, 1993-2 C.B. 269, provides that a state court order that reforms a

trust to meet the requirements of a valid QSST is recognized prospectively.
PLR-118599-18 4

                                     Conclusion

    Based solely on the facts submitted and the representations made within those

submissions, we conclude that X’s S corporation election terminated on Date 2 when
stock was transferred to Trust 1 and Trust 2, ineligible shareholders. We further
conclude that the termination of X’s S corporation election on Date 2 was inadvertent
within the meaning of section 1362(f). Pursuant to the provisions of section 1362(f), X
will be treated as continuing to be an S corporation from Date 2 and thereafter, provided
that X’s S corporation election is valid and not otherwise terminated under section
1362(d).

     Except as specifically ruled upon above, we express or imply no opinion

concerning the federal tax consequences of the facts of this case under any other
provision of the Code. Specifically, we express or imply no opinion regarding X’s
eligibility to be an S corporation or Trust 1 and Trust 2’s eligibility to qualify as a QSST.

  This ruling is directed only to the taxpayer who requested it. According to section

6110(k)(3), this ruling may not be used or cited as precedent.

    Pursuant to the power of attorney on file with this office, we are sending a copy of

this letter to your authorized representative.

                                    Sincerely,


                                    David R. Haglund
                                    David R. Haglund
                                    Branch Chief, Branch 1
                                    (Passthroughs & Special Industries)

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