Missed QSST elections and a later partnership transfer receive S corporation relief

Plain-English summary

An S corporation shareholder transferred shares to two trusts that represented they qualified as qualified subchapter S trusts, but their beneficiaries did not timely file QSST elections. The trusts later transferred their shares to a limited liability company taxed as a partnership, an ineligible S corporation shareholder, and the corporation eventually redeemed those shares. The missed trust elections terminated S status first, and the partnership transfer would have caused another termination if the election had still been in effect. The corporation and affected shareholders represented that both events were inadvertent, were not tax-motivated, and had been reported consistently with continued S and QSST treatment. The IRS granted relief under IRC § 1362(f), treating the corporation as continuously eligible for S status from the first termination date unless its election had otherwise terminated for an unstated reason.

Ruling snapshot

• Question: Can the corporation retain continuous S status after missed QSST elections and a later transfer of shares to an ineligible partnership?
• Outcome: Approved as inadvertent terminations
• Key authorities: IRC §§ 1361(d) and 1362(f); Treas. Reg. § 1.1361-1(j)(6)(ii)

Full text (IRS public release)

 Internal Revenue Service                                          Department of the Treasury
                                                                   Washington, DC 20224

 Number: 202108008                                                 Third Party Communication: None
 Release Date: 2/26/2021                                           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-113105-20
                                                                   Date:
                                                                   December 03, 2020




                                                      LEGEND

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

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

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

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

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

D                 =        ----------------------------------

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

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

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

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

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

Date3             =        --------------------------
PLR-113105-20                                         2


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

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

Date6           =        --------------------------

Date7           =        ------------------

Date8           =        -------------------

N1              =        -----

N2              =        -----------

N3              =        -----------



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

       This responds to a letter dated May 22, 2020, submitted on behalf of X by the
authorized representatives of X, requesting a ruling under §1362(f) of the Internal
Revenue Code (“Code”).

                                                      FACTS

       The information submitted states that X was formed under the laws of State on
Date1 and elected to be an S corporation effective on Date2. At the time of X’s
formation, X was owned equally by A and B. On Date3, A formed Trust1 for the benefit
of C. Also on Date3, A formed Trust2 for the benefit of D. On Date4, A transferred N1
shares of X each to Trust1 and Trust2. 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 filed on behalf of either Trust1 or Trust2 effective on Date4.

        On Date5, Trust1 transferred its N1 shares to Y, a limited liability company
formed by A under the laws of State on Date6 and classified as a partnership for federal
income tax purposes, in exchange for a promissory note in the amount of $N2. In
addition, on Date5, Trust2 transferred its N1 shares of X to Y in exchange for a
promissory note in the amount of $N2. X represents that it had not been informed about
these transfers of X stock to Y, and until recently it was unaware that its S corporation
election would have terminated on Date5 as a result of the stock being transferred to an
ineligible shareholder. On Date7, A (as manager of Y) and B (as president of X) entered
in a redemption agreement whereby X agreed to redeem all of the shares of X held by Y
PLR-113105-20                                  3

in exchange for a promissory note in the amount of $N3. This redemption occurred on
Date8.

       X represents that X and X’s shareholders have always filed tax returns consistent
with X being an S corporation. In addition, X represents that Trust1 and Trust2 have
always filed tax returns consistent with their treatment as QSSTs. 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 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.

                                       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
PLR-113105-20                                  4

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
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 Date4 resulting from the failure by C and D
to properly and timely file QSST elections on behalf of Trust1 and Trust2, respectively.
In addition, X’s S corporation election would have terminated on Date5 as a result of X
stock being transferred to an ineligible shareholder, if X’s election has not previously
terminated on Date4. We conclude that these terminating events 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 on Date4 and thereafter, unless X’s S
corporation election otherwise terminated under § 1362(d) for reasons not stated in this
letter.

         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. In addition,
no opinion is expressed or implied as to whether Trust1 or Trust2 qualify as QSSTs.
PLR-113105-20                                 5

       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.

        In accordance with the Power of Attorney on file with this office, copies of this
letter are being sent to your authorized representatives.

                                       Sincerely,



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

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



cc: