Late QSST elections received inadvertent S termination relief

Plain-English summary

A shareholder transferred S corporation stock to two trusts that otherwise met the qualified subchapter S trust requirements, but the beneficiaries did not timely file QSST elections. The corporation’s S election therefore terminated when the trusts received the shares. The corporation and shareholders had filed consistently with S status, represented that the failures were inadvertent, and agreed to make required adjustments. The IRS allowed S corporation treatment to continue until the later stock sale, conditioned on both beneficiaries filing retroactive QSST elections within 120 days.

Ruling snapshot

• Question: May the corporation receive inadvertent termination relief for two late QSST elections?
• Outcome: approved for the period the trusts held the shares, conditioned on elections being filed 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: 201938001                                                 Third Party Communication: None
Release Date: 9/20/2019                                           Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
                                                                  Person To Contact:
--------------------------------------                            -----------------------, ID No. -------------------
-------------------------------                                   --------------------------------------------------
-------------------------------                                   Telephone Number:
------------------------------------------------------------      --------------------
---                                                               Refer Reply To:
                                                                  CC:PSI:B03
                                                                  PLR-101970-19
                                                                  Date:
                                                                  June 18, 2019


                                                       LEGEND

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

Y                 =        ------------------------------------

Z                 =        --------------------------------------

A                 =         --------------------------
--------------------------------------------------

B                 =         ------------------------
--------------------------------------------------

C                 =         --------------------------
--------------------------------------------------

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

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

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

Date1             =        --------------------------

Date2             =        ----------------

Date3             =        --------------------------

PLR-101970-19                                         2


Date4           =       ---------------------

Date5           =       ---------------------------

N1              =       -----

N2              =       ------

N3              =       ---


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

       This responds to a letter dated December 21, 2018, submitted on behalf of X and
Z by the authorized representative of X and Z, requesting a ruling under §1362(f) of the
Internal Revenue Code (“Code”).

                                                      FACTS

        The information submitted states that X was incorporated under the laws of State
on Date1 and elected to be an S corporation effective on Date2. At the time of X’s
incorporation, A owned N1 shares of X, which comprised all of the outstanding shares
of X. On Date3, A established Trust1 for the benefit of B, and Trust2 for the benefit of
C. At that time, A transferred N2 shares of stock of X to each of Trust1 and Trust2.
After those transfers, A retained N3 shares of X. X represents that Trust1 and Trust2
have always met the requirements as a Qualified Subchapter S Trust (QSST), except
that no QSST election had been timely filed on behalf of either Trust1 or Trust2 effective
on Date3. On Date4, Y purchased all of the outstanding shares of X from A, Trust1,
and Trust2. On Date5, X was merged with and into Z, a limited liability company formed
under the laws of State that is wholly-owned by Y.

       X represents that X and X’s shareholders have filed tax returns consistent with X
being an S corporation since Date3 (until Date4). X further represents that the
circumstances resulting in the termination of X’s S corporation election were inadvertent
and were not motivated by tax avoidance or retroactive tax planning. X and each
person who was a shareholder of X at any time since Date3 (until Date4) agree to make
any adjustments (consistent with the treatment of X as an S corporation) as may be
required by the Secretary with respect to such period.

PLR-101970-19                                  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 a “small business corporation” means a
domestic corporation that is not an ineligible corporation and that 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(d)(1) provides, in pertinent part, that a 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 § 678(a)) of that portion of the QSST’s S corporation stock to which the
election under § 1361(d)(2) applies. Under § 1361(d)(2)(A), a beneficiary of a QSST
may elect to have § 1361(d) apply. Under § 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 § 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 income 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 § 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 Tax 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 § 1.1361-1(j)(6)(ii).

      Section 1362(a)(1) 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 1362(d)(2) provides that 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

PLR-101970-19                                  4

corporation. A termination of an S corporation election under § 1362(d)(2) is effective
on or after the date of cessation.

        Section 1362(f) provides, in pertinent part, 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
the termination, steps were taken so that the corporation is a small business
corporation; and (4) the corporation, and each person who was a shareholder of the
corporation at any time during the period specified under § 1362(f), agrees to make the
adjustments (consistent with the treatment of the corporation as an S corporation) as
may be required by the Secretary for that period, then, notwithstanding the
circumstances resulting in such termination, the corporation shall 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 Date3 due to the failure by B and C to
properly and timely file QSST elections on behalf of Trust1 and Trust2, respectively.
We conclude that this terminating event was inadvertent within the meaning of
§ 1362(f). Pursuant to the provisions of § 1362(f), X will be treated as continuing to be
an S corporation on Date3 until Date4, unless X’s S corporation election otherwise
terminated under § 1362(d).

        This ruling is contingent upon B and C filing QSST elections on behalf of Trust1
and Trust2, respectively, with an effective date of Date3, within 120 days of the date of
this letter. A copy of this letter should be attached to each QSST election.

         Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed or implied regarding X’s
eligibility to be an S corporation or the validity of its S corporation election. Further, no
opinion is expressed or implied as to whether Trust1 and Trust2 qualify as QSSTs.

       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 request for a ruling, it is subject to verification on examination.

      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.

PLR-101970-19                                  5

         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representative.

                                       Sincerely,



                                       Caroline E. Hay
                                       Assistant to the Branch Chief, Branch 3
                                       Office of Associate Chief Counsel
                                       (Passthroughs & Special Industries)

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