Inadvertent S corporation termination relief granted for late QSST elections

Plain-English summary

Five trusts held stock in an S corporation but their beneficiaries did not timely file qualified subchapter S trust elections when grantor-trust treatment ended. Those failures terminated, or would have terminated, the corporation's S election on three dates. The IRS found the terminations inadvertent because the parties did not intend to end S status, had consistently reported the corporation as an S corporation, and agreed to any required adjustments. The corporation would continue to be treated as an S corporation if its election was not otherwise terminated. Relief required each current income beneficiary to file the applicable QSST election within 120 days, effective on the relevant original date.

Ruling snapshot

• Question: May the corporation retain S status despite five beneficiaries' late QSST elections?
• Outcome: approved
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. §§ 1.1361-1(j) and 1.1362-4

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202009003                                              Third Party Communication: None
Release Date: 2/28/2020                                        Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.02-02,
              1361.03-02                                       Person To Contact:
                                                               --------------, ID No. -----------------
--------------------------------------------                   Telephone Number:
-----------------------------                                  --------------------
------------------------------                                 Refer Reply To:
---------------------                                          CC:PSI:B01
                                                               PLR-108916-19
                                                               Date:
                                                               October 16, 2019




LEGEND

X                 =         --------------------------------------------
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A                 =        ---------------------

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

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

Trust 1           =         ------------------------------------------------------------
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Trust 2           =         -----------------------------------------------------
----------------------------------------------------

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

Trust 4           =         -----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
                           --------------------------------
----------------------------------------------------

Trust 5           =         ---------------------------------------------------------------------------------------
----------------------------------------------------

Date 1            =        ----------------
PLR-108916-19                                       2


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

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

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

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

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

Date 7          =      -----------------------

Date 8          =      --------------------------

Date 9          =      ----------------------

Date 10         =      ----------------------

Year            =      -------

State           =      --------


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

This responds to a letter dated April 11, 2019, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under
§ 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted and representations within, X was incorporated
on Date 1 under the laws of State, and elected to be taxed as an S corporation,
effective Date 2.

On Date 3, A established Trust 1 and Trust 2 as grantor trusts. On Date 4, A
transferred stock of X to Trust 1 and Trust 2. The terms of Trust 1 and Trust 2 provide
that each trust would cease to be a grantor trust to A at the earlier of (1) A’s death, (2)
the death of the primary beneficiary, or (3) Date 6. A died on Date 7. The primary
beneficiaries of Trust 1 and Trust 2 were still alive upon A’s death. Thus, Trust 1 and
Trust 2 ceased to be grantor trusts to A on Date 6. The beneficiaries of Trust 1 and
Trust 2 failed to timely file QSST elections for Trust 1 and Trust 2 effective Date 6, thus
causing X’s S corporation election to terminate on Date 6.
PLR-108916-19                                 3

On Date 5, B established Trust 3 and Trust 4 as grantor trusts and transferred stock of
X to Trust 3 and Trust 4. B indicated that, effective Date 9, he wished to release his
grantor power for Trust 3 and Trust 4. Although a document was not identified releasing
B’s grantor power, X represents that Trust 3 and Trust 4 have been treated since Date 9
as if each primary beneficiary were the grantor of their respective trust under § 678.
The beneficiaries of Trust 3 and Trust 4 failed to timely file QSST elections for Trust 3
and Trust 4 effective Date 9. Thus if X’s S corporation election had not previously
terminated on Date 6, X’s S corporation election would have terminated on Date 9.

On Date 8, C established Trust 5 as a grantor trust and transferred stock of X to Trust 5.
X represents that, on Date 10, C intended that Trust 5 cease being treated as a grantor
trust to C. Although the trust agreement did not include terms treating Trust 5 as a
§ 678 trust, X represents that Trust 5 has been treated as if its primary beneficiary were
the grantor since Date 10. The beneficiary of Trust 5 failed to timely file a QSST
election for Trust 5 effective Date 10. Thus, if X’s S corporation election had not
previously terminated on Date 6 or Date 9, X’s S corporation election would have
terminated on Date 10.

X represents that the failure to file QSST elections was discovered in Year. X
represents that the failure to file the QSST elections was unintentional and was not
motivated by tax avoidance or retroactive tax planning. X represents that all income
has been reported on all affected returns of X and all of its shareholders consistent with
the treatment of X as an S corporation and that neither X nor any of its shareholders
intended to terminate X’s S election.

In addition, X represents that Trust 1, Trust 2, Trust 3, Trust 4 and Trust 5 have qualified
as QSSTs under § 1361(d) at all times since Trust 1, Trust 2, Trust 3, Trust 4 and Trust
5 acquired their X stock, and other than the inadvertent failure to timely file QSST
elections for Trust 1, Trust 2, Trust 3, Trust 4 and Trust 5, X has qualified as a small
business corporation at all times since its election on Date 2. Lastly, X represents that
X and its shareholders agree to make any adjustments required as a condition of
obtaining relief under the inadvertent termination rule as provided under § 1362(f) of the
Code that may be required by the Secretary.

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) 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 § 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 1
PLR-108916-19                                    4

class of stock.

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 QSST’s
beneficiary will be treated as the owner (for purposes of § 678(a)) of that portion of the
trust that consists of 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), this 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 1 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 the 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 1 individual who is a citizen or resident of the United States.

Section 1362(a) provides, in part, that a small business corporation may elect to be an
S corporation.

Section 1362(d)(2)(A) 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, in relevant part, that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (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 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 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 termination, such corporation shall
be treated as an S corporation during the period specified by the Secretary.

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
PLR-108916-19                                  5

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 1.1361-1(j)(6)(iii)(A) provides that if S corporation stock is transferred to a trust,
the QSST election must be made within the 16-day-and-2-month period beginning on
the day that the stock is transferred to the trust.

Section 1.1361-1(j)(6)(iii)(E) provides that if a corporation's S election terminates
because of a late QSST election, the corporation may request inadvertent termination
relief under § 1362(f).

Section 1.1361-1(j)(7)(i) provides that the income beneficiary who makes the QSST
election and is treated (for purposes of § 678(a)) as the owner of that portion of the trust
that consists of S corporation stock is treated as the shareholder for purposes of
§§ 1361(b)(1), 1366, 1367, and 1368.

Section 1.1362-4(b) provides, in relevant part, that the determination of whether a
termination was inadvertent is made by the Commissioner. The corporation has the
burden of establishing that under the relevant facts and circumstances the
Commissioner should determine that the termination was inadvertent. The fact that the
terminating event was not reasonably within the control of the corporation and was not
part of a plan to terminate the election, or the fact that the terminating event or
circumstance took place without the knowledge of the corporation, notwithstanding its
due diligence to safeguard itself against such an event or circumstance, tends to
establish that the termination of the election was inadvertent.

Section 1.1362-4(d) provides that the Commissioner may require any adjustments that
are appropriate. In general, the adjustments required should be consistent with the
treatment of the corporation as an S corporation during the period specified by the
Commissioner.

Section 1.1362-4(f) provides, in relevant part, that the status of the corporation after the
terminating event and before the determination of inadvertence is determined by the
Commissioner. Inadvertent termination relief may be granted retroactively for all years
for which the terminating event is effective, in which case the corporation is treated as if
its election had not terminated.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
X’s S corporation election terminated on Date 6, and that if X’s S corporation election
had not terminated on Date 6 that X’s S corporation election would have terminated on
Date 9 and Date 10. We further conclude that the terminations of X’s S election on
Date 6, Date 9, and Date 10 were 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 as
PLR-108916-19                                6

of Date 6 and thereafter, provided that X's S corporation election is not otherwise
terminated under § 1362(d).

This relief is contingent on the current income beneficiaries of Trust 1, Trust 2, Trust 3,
Trust 4 and Trust 5, filing QSST elections for Trust 1, Trust 2, Trust 3, Trust 4 and Trust
5 within 120 days from the date of this letter. The current income beneficiaries of Trust
1 and Trust 2 must file QSST elections for Trust 1 and Trust 2, respectively, effective
Date 6. The current income beneficiaries of Trust 3 and Trust 4 must file QSST
elections for Trust 3 and Trust 4, respectively, effective Date 9. The current income
beneficiary of Trust 5 shall file a QSST election for Trust 5 effective Date 10. A copy of
this letter should be attached to the elections.

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, Trust 2, Trust 3, Trust 4 and Trust 5’s eligibility as QSSTs.

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 whether Trust 1, Trust 2, Trust 3, Trust 4, and Trust 5, are otherwise valid
QSSTs.

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3),
this ruling 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-108916-19                                7

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



                                      Sincerely,


                                      Joy C. Spies
                                      Joy C. Spies
                                      Senior Technician Reviewer, Branch 1
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)



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



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