S corporation preserved after a trust missed its QSST election

Plain-English summary

An S corporation's stock passed through a chain of trusts after its sole shareholder died. While that shareholder was alive, a grantor trust held the shares and qualified as an eligible S corporation shareholder. When the shareholder died, the grantor trust stopped qualifying automatically and the stock passed under the will to a second trust. That second trust could have kept the company eligible by making a "qualified subchapter S trust" (QSST) election, but no election was filed, so the trust was an ineligible shareholder and the corporation's S election terminated. The stock later moved to a third trust, which did file a QSST election, though an erroneous one. The company represented that the missed election was an innocent mistake, not tax planning. The IRS agreed the termination was inadvertent under section 1362(f) and also found that the third trust had "substantially complied" with the QSST election rules. It ruled that the corporation may be treated as remaining an S corporation from the termination date, provided the beneficiary of the second trust now files a proper QSST election (effective as of the correct date) within 120 days. If that condition is not met, the relief is void.

Ruling snapshot

• Question: Was the termination of the corporation's S election, caused by a trust's failure to make a timely QSST election, inadvertent under IRC § 1362(f) so the S status can be preserved?
• Outcome: Approved (inadvertent termination relief granted, contingent on filing a valid QSST election within 120 days)
• Key authorities: IRC §§ 1361(c)(2), 1361(d) (QSST rules), 1362(d)(2), and 1362(f); Treas. Reg. § 1.1361-1(j)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202233005 Third Party Communication: None
Release Date: 8/19/2022 Date of Communication: N/A
Index Number: 1361.00-00, 1361.01-00,
1361.03-00, 1361.03-03, Person To Contact:
1362.00-00, 1362.02-00, ----------------------, ID No. -----------------
1362.04-00 Telephone Number:
-------------------
---------------------- Refer Reply To:
------------------------------------------ CC:PSI:B3
-------------------------------------- PLR-123712-21
----------------------------- Date:
-------------------------------- May 17, 2022

                                               Legend

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

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

State = --------

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

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

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

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

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

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

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

Date 4 = -------------------
PLR-123712-21 2

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

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

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

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

                                      Facts

   The information submitted states that X is a corporation which is a successor

corporation of Y, was incorporated under the laws of State on Date 1. Y elected to be
an S corporation effective Date 2. A was the sole initial shareholder of Y. On Date 3, A
transferred all A’s shares in X to Trust 1, a grantor trust that was treated (under subpart
E of part I of subchapter J of chapter 1) as entirely owned by A. Trust 1 was an eligible
shareholder under § 1361(c)(2)(A)(i). On Date 4, A died, causing Trust 1 to cease
being a grantor trust. On Date 4, pursuant to terms of A’s will, Trust 1 transferred its
shares in X from Trust 1 to Trust 2. X represents that beginning Date 4, Trust 2 would
have qualified as a qualified subchapter S trust (“QSST”) under § 1361(d)(3), however
no QSST election was filed. Consequently, Trust 2 was an ineligible shareholder, and,
as a result, X’s S corporation election terminated on Date 4.

    On Date 5, Trust 2 transferred its shares in X to Trust 3. X represents that

beginning Date 5, Trust 3 qualified as a QSST under § 1361(d)(3). However, Trust 3
filed an erroneous QSST election.

    X represents that there was no tax avoidance or retroactive tax planning involved

in the failure of Trust 2 to make a timely QSST election. X and its shareholders agree to
make any adjustments consistent with the treatment of X as an S corporation and Trust
2 as eligible shareholders, as 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)(B) provides that the term “small business corporation” means

a domestic corporation that is not an ineligible corporation and that does not, among
other requirements, 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.
PLR-123712-21 3

   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 of the Code)
as owned by an individual who is a citizen or resident of the United States may be a
shareholder.

    Section 1361(c)(2)(B)(i) provides that for purposes of § 1361(b)(1), in the case of

a trust described in § 1361(c)(2)(A)(i), the deemed owner shall be treated as the
shareholder.

   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), the trust is treated as a trust
described in § 1361(c)(2)(A)(i), and 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 may elect to have § 1361(d)(1)
apply.

    Section 1361(d)(2)(D) provides that an election under § 1362(d)(2) shall be

effective up to 15 days and 2 months before the date of the election.

    Section 1361(d)(3) provides that 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 only be 1 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 such 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 a 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 a QSST election under § 1361(d)(2) by
signing and filing with the service center with which the corporation files its income tax
return the applicable form 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)(A) provides that an election under § 1362(a) is 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(d)(2)(B) provides that any termination under § 1362(d)(2)(A)
is effective on and after the date of cessation.
PLR-123712-21 4

    Section 1362(f) provides that if (1) an election under § 1362(a) or

§ 1361(b)(3)(B)(ii) by any corporation (i) 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 (ii) was terminated
under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (2) the Secretary determines that the
circumstances resulting in such ineffectiveness or termination were inadvertent; (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
such ineffectiveness or termination, steps were taken so that the corporation for which
the election was made or the termination occurred is a small business corporation or a
QSub, as the case may be, or to acquire the required shareholder consents; and (4) the
corporation for which the election was made or the termination occurred, and each
person who was a shareholder of the corporation at any time during the period specified
pursuant to § 1362(f), agree to make the adjustments (consistent with the treatment of
the corporation as an S corporation or a QSub, as the case may be) as may be required
by the Secretary with respect to this period, then, notwithstanding the circumstances
resulting in such ineffectiveness or termination, the corporation shall be treated as an S
corporation or a QSub, as the case may be, 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 Date 4 when Trust 2 became an ineligible
shareholder, and that the termination was inadvertent within the meaning of § 1362(f).
We also conclude that Trust 3 substantially complied with the requirements for an
election to be treated as a QSST under § 1.1361-1(j)(6)(ii). Consequently, we rule that
X will be treated as an S corporation from Date 4 and thereafter provided that X’s S
corporation election is otherwise valid and not otherwise terminated under § 1362(d).

   These rulings are contingent on the beneficiary (or beneficiary’s representative)

of Trust 2 filing a QSST election effective Date 4 with the appropriate service center
within 120 days of the date of this letter. A copy of this letter should be attached to the
QSST election. If the above conditions are not met, then this ruling is null and void.

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the facts described above under any other provision of
the Code, including whether X was otherwise a valid S corporation and whether Trust 2
or Trust 3 are valid QSSTs within the meaning of § 1361(d)(3).

  The rulings contained in this letter are 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 rulings requested, it is subject to verification on
examination.
PLR-123712-21 5

   Pursuant to a power of attorney on file, we are sending a copy of this letter to X’s

authorized representatives.

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

of the Code provides that it may not be used or cited for precedent.

                                  Sincerely,



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

Enclosure:
Copy for § 6110 purposes

cc: ------------------------------