S corporation keeps its status after several trusts accidentally became ineligible shareholders

Plain-English summary

An S corporation can only be owned by certain kinds of shareholders, and some trusts qualify only if the beneficiary files a timely "QSST" election. Here a corporation's S election was accidentally terminated when two trusts that received stock through a will failed to make QSST elections on time, and two other trusts also would have caused a termination for similar timing failures. The corporation asked the IRS for relief under § 1362(f), which lets the IRS overlook an inadvertent termination if the company fixes the problem and everyone agrees to be treated as if it stayed an S corporation. The IRS found the termination was inadvertent and not motivated by tax avoidance, so it treated the corporation as continuing to be an S corporation, on the condition that the trust beneficiaries file the missing QSST elections within 120 days. This matters because a botched S election can trigger corporate-level tax; § 1362(f) relief is the common cure when the mistake was honest and promptly corrected.

Ruling snapshot

• Question: Was the termination of the corporation's S election inadvertent, so it can be treated as continuing to be an S corporation under § 1362(f)?
• Outcome: Approved (relief granted, subject to filing the QSST elections within 120 days)
• Key authorities: IRC §§ 1362(f), 1361(c)(2), 1361(d) (QSST); Treas. Reg. § 1.1361-1(j)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202238002                                             Third Party Communication: None
Release Date: 9/23/2022                                       Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                              Person To Contact:
-------------------------------                               ----------------------, ID No. -----------------
---------------------------                                   Telephone Number:
------------------                                            --------------------
----------------------------                                  Refer Reply To:
----------------------------                                  CC:PSI:B01
------------------------------------------------              PLR-100352-22
                                                              Date:
                                                              June 30, 2022




                                                    LEGEND

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

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

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

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

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

E              =      --------------------------
                      -------------------------

F              =      -------------------
                      -------------------------

G              =      --------------------------
                      -------------------------

TrustA         =      ----------------------------------------------------------------------
                      -----------------------
PLR-100352-22                                          2

 TrustB        =     ----------------------------------------------------------------------
                     -----------------------

 TrustC        =     ------------------------------------------------
                     -----------------------

 TrustF        =     ----------------------------------------
                     -----------------------

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

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

 Date3         =     ---------------------------

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

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

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

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

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

 Date9         =     --------------------------

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

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



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

This letter responds to a letter dated December 17, 2021, and subsequent
correspondence, submitted on behalf of X by its authorized representative, requesting
relief under § 1362(f) of the Internal Revenue Code (Code).

                                                   FACTS

According to the information submitted and representations within, X was incorporated
under the laws of State on Date1. X filed an election under § 1362(a) of the Code to be
treated as an S corporation effective Date2.
PLR-100352-22                                3

A, an individual, owned shares of X stock and died on Date3. On Date 4, A's estate
transferred shares of X stock to TrustA and TrustB pursuant to the terms of A's will.
TrustA and TrustB each qualified as an eligible S corporation shareholder for the two-
year period beginning on the day the shares of X stock were transferred to them and
ending Date5 under § 1361(c)(2)(A)(iii).

X represents that TrustA and TrustB each met the requirements of a qualified
subchapter S trust (QSST) within the meaning of § 1361(d)(3). However, B, the income
beneficiary of both TrustA and TrustB, failed to timely make an election under
§ 1361(d)(2) to treat TrustA and TrustB as a QSST. Consequently, TrustA and TrustB
were ineligible shareholders of X and X's S corporation status was terminated on Date5.
Nevertheless, X represents that B has federal income tax returns consistent with having
valid a QSST election in effect for TrustA and TrustB since Date5.

On Date7, C, an individual, transferred shares of X stock to TrustC. TrustC established
two separate shares for beneficiary D and beneficiary E. Each TrustC share is treated
as a separate share under § 663(c). X represents that it was intended that each share
of TrustC qualify as a QSST under § 1361(d)(3). However, neither share of TrustC was
a valid QSST because its terms did not meet the requirements of § 1361(d)(3) and D
and E failed to timely make an election under § 1362(d)(2) to treat their respective share
of TrustC as a QSST effective Date 7. Consequently, each share of TrustC was an
ineligible shareholder of X and X's S corporation status would have terminated on
Date7, had it not already terminated on Date5. Nevertheless, X represents that D and E
have each filed federal income tax returns consistent with having valid a QSST election
in effect for TrustC since Date7. Further, X represents that effective Date10, the
governing instrument of TrustC was amended such that TrustC's terms met the
requirements of a QSST under § 1361(d)(3).

F, an individual, transferred shares of X stock to TrustF. TrustF was treated (under
subpart E of part I of subchapter J of chapter 1 of the Code) as a grantor trust owned by
F until Date6 when F died and TrustF ceased to qualify as a shareholder under
§ 1361(c)(2)(A)(i). The trustee of TrustF failed to distribute the shares of X stock to G,
an individual, until Date9, two days after the eligibility period provided in
§ 1361(c)(2)(A)(ii) expired on Date8. Consequently, TrustF was an ineligible
shareholder of X and X's S corporation status would have terminated on Date8, had it
not already terminated on Date5.

X represents that X and its shareholders have filed tax returns consistent with being an
S corporation for all relevant periods. X further represents that the circumstances
resulting in the termination of its S corporation election were inadvertent and were not
motivated by tax avoidance or retroactive tax planning. X and its shareholders have
agreed to make adjustments consistent with the treatment of X as an S corporation, as
may be required by the Secretary.

                                 LAW AND ANALYSIS
PLR-100352-22                                 4


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) provides that the term "small business corporation" means 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 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)(A)(ii) provides that, for purposes of § 1361(b)(1)(B), a trust which
was described in clause § 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(c)(2)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust with
respect to stock transferred to it pursuant to the terms of a will may be a shareholder,
but only for the 2-year period beginning on the day on which such stock is transferred to
it.

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)(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 § 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. A substantially separate and independent share of a trust
PLR-100352-22                                 5

within the meaning of § 663(c) shall be treated as a separate trust for purposes of
§ 1361(d)(3) and § 1361(c).

Section 1.1361-1(j)(7)(i) of the Income Tax Regulations 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 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(a)(2) provides that an election to be an S corporation shall be valid only if
all persons who are shareholders in such corporation on the day on which such election
is made consent to such election.
.
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(d)(2)(B) provides that any termination under § 1362(d)(2)(A)
is effective on and after the date of cessation.

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

                                      CONCLUSION

Based solely on the information submitted and the representations made, we conclude
that X's S corporation election terminated on Date5, when TrustA and TrustB became
ineligible shareholders. We also conclude X's S corporation election would have
terminated on Date7 when the separate shares of TrustC became ineligible
PLR-100352-22                                 6

shareholders, had it not already terminated on Date5. Additionally, we conclude that X's
S corporation would have terminated on Date8, when TrustF became an ineligible
shareholder, had it not already terminated on Date5.

We further conclude that the circumstances resulting in the termination of X's S
corporation election were inadvertent 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 Date5, and thereafter, provided that X's S corporation election was
valid and was not otherwise terminated under § 1362(d) for reasons not addressed in
this letter.

We further conclude that: (1) TrustA and TrustB will be treated as QSSTs from Date5
and thereafter provided B files a QSST election for both trusts effective Date5 with the
appropriate service center within 120 days of this ruling;(2) each separate share of
TrustC will be treated as a QSST from Date7 and thereafter provided D and E each file
a QSST election with respect to their share of TrustC effective Date7 with the
appropriate service center within 120 days of this ruling; and (3) TrustF will be treated
as an eligible S corporation shareholder for the period beginning on Date8 and ending
on Date9. A copy of this letter should be attached to each QSST election.

If the above conditions are not met, then this ruling is null and void. Furthermore, if
these conditions are not met, X must notify the service center with which it filed its S
corporation election that its election terminated on Date5.

Except as specifically set forth above, we express or imply no opinion concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, we express or imply no opinion regarding X's eligibility to be an S
corporation. In addition, we express or imply no opinion as to whether TrustA, TrustB,
and the separate shares TrustC are eligible to elect to be treated as QSSTs.

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 upon examination.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.
PLR-100352-22                                  7


In accordance with the power of attorney on file with this office, we are sending copies
of this letter to X's authorized representative.


                                  Sincerely,


                                  Holly Porter
                                  Associate Chief Counsel
                                  (Passthroughs & Special Industries)


                                           /s/
                                  By: _____________________
                                      Jennifer N. Keeney
                                      Senior Counsel, Branch 1
                                      Office of the Associate Chief Counsel




Enclosure
Copy for § 6110 purposes


cc: