An S corporation's accidental loss of S status, caused by missed QSST elections after the grantors died, is treated as an inadvertent termination

Plain-English summary

An S corporation had its stock held in a grantor trust, an eligible S corporation shareholder while the grantors were alive. When the grantors died, the stock passed into separate trusts for individual beneficiaries. Those trusts met the requirements to be qualified subchapter S trusts (QSSTs), but each beneficiary had to file a QSST election to keep the trust as an eligible shareholder, and none of them did. Because an ineligible shareholder held the stock, the company's S corporation election terminated. The company asked the IRS for relief under section 1362(f), which lets the IRS disregard a termination it finds was inadvertent. The IRS granted relief: it found the failure to file the QSST elections was inadvertent, so the company is treated as having continued as an S corporation, on the condition that each beneficiary files the missing QSST election within 120 days. This spares the company and its owners from being taxed as a regular C corporation for the intervening years.

Ruling snapshot

• Question: Was the termination of the company's S corporation election, caused by the beneficiaries' failure to file QSST elections, inadvertent under § 1362(f)?
• Outcome: Approved (inadvertent termination; S corporation status continues, subject to filing the QSST elections)
• Key authorities: IRC § 1362(f), § 1361(c)(2), § 1361(d); Treas. Reg. § 1.1361-1(j)(6)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202144002 Third Party Communication: None
Release Date: 11/5/2021 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:B01
PLR-101865-21
Date:
July 26, 2021

Legend

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

A = -------------------
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B = --------------------
------------------------

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

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

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

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

Grantors = -----------------------
-------------------------

                     ----------------------
                     -------------------------

PLR-101865-21 2

State = ------

Year = -------

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

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

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

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

This letter responds to a letter dated January 15, 2021, and additional information,
submitted on behalf of X by its authorized representative requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

FACTS

The information submitted states that X was incorporated under the laws of State on D1
and elected to be an S corporation effective D2. In Year, Trust 1 owned shares of X
stock. X represents that Trust 1 was treated under subpart E of part I of subchapter J of
chapter 1 of the Code as entirely owned by Grantors and, thus, an eligible shareholder
under § 1361(c)(2)(A)(i). In Year, Grantors died. Under the terms of Trust 1 upon the
death of Grantors, the trustee was authorized to allocate the X stock to separate S
trusts. The separate S trusts were funded with the X stock on D3. X represents that the
separate S trusts, later reformed as Trust 2, Trust 3, and Trust 4, satisfied the qualified
subchapter S trust (QSST) requirements under § 1361(d)(3). However, A, B, and C,
Trust 2's, Trust 3’s, and Trust 4’s, respective current income beneficiaries, failed to
make elections under § 1361(d)(2) to treat the separate S trusts, later reformed as Trust
2, Trust 3, and Trust 4 as QSSTs effective D3. Therefore, X's S corporation election
terminated on D3.

X represents that the failure to file the QSST elections was inadvertent and was not
motivated by tax avoidance or retroactive tax planning. X represents that A, B, and C
respectively reported the separate S trusts’ and Trust 2's, Trust 3’s, and Trust 4’s
allocable share of X's income (or loss) consistent with the treatment of the separate S
trusts and Trust 2, Trust 3, and Trust 4 as QSSTs on all affected returns. Finally, 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.
PLR-101865-21 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) 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 one
class of stock.

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 a shareholder of an S
corporation.

Section 1361(c)(2)(A)(ii) provides that for purposes of § 1361(b)(1)(B), a trust which was
described in § 1361(c)(2)(A)(i) immediately before the death of the deemed owner and
which continues in existence after such death may be a shareholder, but only for the 2-
year period beginning on the day of the deemed owner's death.

Section 1361(d)(3) defines a QSST as 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 the termination of the trust during the
life of the current income beneficiary, the trust shall distribute all of its assets to such
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 1361(d)(1) provides that in the case of a QSST with respect to which a
beneficiary makes an election under § 1361(d)(2) — (A) such trust shall be treated as a
trust described in § 1361(c)(2)(A)(i) and, (B) for purposes of § 678(a), the beneficiary of
such trust shall be treated as the owner of that portion of the trust which 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 (or his legal representative)
may elect to have § 1361(d) apply.

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 under § 1361(d)(2) by signing
PLR-101865-21 4

and filing, with the service center with which the S 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(d)(2)(A) 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.

Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 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 the corporation at any
time during the period specified pursuant to § 1362(f), agrees to make any adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to the period, then, notwithstanding the
circumstances resulting in the termination, the corporation will be treated as an S
corporation during the period specified by the Secretary.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X's S
corporation election terminated on D3 when the separate S trusts which were later
reformed as Trust 2, Trust 3, and Trust 4 became ineligible shareholders. We further
conclude that the termination constituted 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 that X's S
corporation election was valid and was not otherwise terminated under § 1362(d).

This ruling is contingent on A, B, and C respectively filing QSST elections for the
separate S trusts which were later reformed as Trust 2, Trust 3, and Trust 4 effective
D3, with the appropriate service center within 120 days from the date of this letter. A
copy of this letter should be attached to the QSST election.

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 the separate S trusts’ or Trust 2's, Trust 3’s, and Trust 4’s eligibility to be
a QSST.

This ruling is directed only to the taxpayer that requested it. According to § 6110(k)(3),
this ruling may not be used or cited as precedent.
PLR-101865-21 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 ruling request, it is subject to verification on examination.

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

                                  Sincerely,

                                  /s/

                                  Laura C. Fields
                                  Branch Chief, Branch 1
                                  (Passthroughs & Special Industries)

Enclosure

   Copy for § 6110 purposes

cc: