Inadvertent-termination relief for an S corporation after a trust beneficiary missed the QSST election

Plain-English summary

A small business made an S corporation election, then transferred shares to a trust. The trust could have qualified to hold S corporation stock as a "qualified subchapter S trust" (QSST), but its beneficiary never filed the required QSST election on time. Under the tax rules, that lapse meant the corporation had an ineligible shareholder, which automatically terminated its S corporation status and would expose it to corporate-level tax. The company asked the IRS for relief under section 1362(f), which lets the IRS forgive an "inadvertent" termination. The company represented that the failure was not tax-motivated, that it and its shareholders had kept filing as an S corporation, and that they would make any adjustments the IRS requires. The IRS ruled the termination was inadvertent and that the company will be treated as remaining an S corporation without interruption, provided the trust beneficiary files the missing QSST election (effective as of the original transfer date) within 120 days of the ruling.

Ruling snapshot

• Question: Was the termination of a company's S corporation election, caused by a trust beneficiary's failure to timely make a QSST election, an inadvertent termination eligible for relief under section 1362(f)?
• Outcome: Approved (inadvertent-termination relief; S status preserved, contingent on filing the QSST election within 120 days).
• Key authorities: IRC §§ 1362(f), 1361(d), 1361(c)(2), 1361(b); Treas. Reg. § 1.1361-1(j)(6).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202210001 Third Party Communication: None
Release Date: 3/11/2022 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------- -----------------, ID No. -----------------
----------------------- Telephone Number:
---------------------------- --------------------
------------- Refer Reply To:
------------------------------- CC:PSI:03
------------------------- PLR-105040-21
Date:
December 14, 2021

Legend:

Company: = ----------------------------------------
----------------------

State = --------

Trust: = ----------------------------------------------------------------------------------------
--------
------------------------

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

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

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

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

   This responds to a letter dated February 1, 2021, submitted on behalf of

Company by its authorized representatives, requesting a ruling under § 1362(f) of the
Internal Revenue Code.
FACTS

   The information submitted states that Company was incorporated under the laws

of State in Date 1. Company elected to be an S corporation effective on Date 2. On
Date 3, shares of Company were transferred to Trust.
PLR-105040-21 2

    Company represents that the Trust was eligible to elect qualified subchapter S

trust (QSST) treatment under § 1361(d). However, the beneficiary of Trust failed to
timely make a QSST election. Therefore, Company’s S election terminated on Date 3.

   Company represents that Company and each of its shareholders have filed

consistently with the treatment of Company as an S corporation since Date 3.
Company represents that the termination was not motivated by tax avoidance or
retroactive tax planning. Company and its shareholders have agreed to make any
adjustments that the Commissioner may require, consistent with the treatment of
Company as an S corporation.

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

   Section 1361(b)(1)(B) provides that the term “small business corporation” means

a domestic corporation, which is not an ineligible corporation and which 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(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 an S corporation
shareholder.

   Section 1361(d)(1) provides that in the case of a QSST for which a beneficiary

makes an election under § 1361(d)(2), the trust is treated as a trust described in
§ 1361(c)(2)(A)(i), and for purposes of § 678(a), the beneficiary of the trust shall be
treated as the owner of that portion of the trust that 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 may elect to have

§ 1361(d) apply. Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary
of a QSST must make the election under § 1361(d)(2) by signing and filing with the
service center with which the corporation files its income tax returns the applicable form
or a statement including the information listed in § 1.1361-1(j)(6)(ii).

   Section 1362(d)(2) provides that (A) in general, 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
PLR-105040-21 3

business corporation, and (B) any termination under § 1362(d)(2) shall be effective on
and after the date of cessation.

    Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any

corporation (A) was not effective for the taxable year for which made (determined
without regard to § 1362(b)(2)) by reason of a failure to meet the requirements of
§ 1361(b) or to obtain shareholder consents or (B) was terminated under § 1362(d)(2)
or (3), (2) the Secretary determines that the circumstances resulting in the
ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of
time after discovery of the circumstances resulting in the ineffectiveness or termination,
steps were taken (A) so that the corporation is a small business corporation or (B) to
acquire the shareholder consents, and (4) the corporation and each person who was a
shareholder of the corporation at any time during the period specified pursuant to
§ 1362(f), agrees to make such adjustments (consistent with the treatment of the
corporation as an S corporation) as may be required by the Secretary with respect to
such period, then, notwithstanding the circumstances resulting in the ineffectiveness or
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 the representations made, we conclude

that Company’s S corporation election terminated on Date 3, because of the inadvertent
failure of the beneficiary of Trust to make a QSST election, and that this termination of
Company’s S election was an inadvertent termination within the meaning of § 1362(f).
Accordingly, pursuant to the provisions of § 1362(f), Company will be treated as
continuing to be an S corporation from Date 3 and thereafter, provided Company’s S
corporation election was valid and not otherwise terminated under § 1362(d).

   This ruling is contingent upon the beneficiary of Trust filing a QSST election, with

an effective date of Date 3, with the appropriate service center within 120 days of the
date of this ruling. A copy of this letter should be attached to the QSST election. If the
conditions are not met, this ruling is null and void.

   Except as specifically set forth above, no opinion is expressed concerning the

federal tax consequences of the facts described above under any other provision of the
Code, including whether Company is a small business corporation under § 1361(b), or
whether the Trust is a QSST within the meaning of § 1361(d)(3).

  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
PLR-105040-21 4

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.

    This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

provides that it may not be used or cited as precedent. Pursuant to a power of attorney
on file, a copy of this letter is being sent to Company’s 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 for § 6110 purposes

cc: