Late QSST election did not end the corporation's S status

Plain-English summary

An individual placed S corporation shares in a revocable grantor trust and later died. The trust remained an eligible S corporation shareholder for two years after the owner's death, but its sole income beneficiary failed to make a timely qualified subchapter S trust election after that period. The corporation consistently filed as an S corporation and represented that the missed election was inadvertent rather than tax planning. The IRS treated the S election as continuing, conditioned on the beneficiary filing the QSST election within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after a trust became an ineligible shareholder because its beneficiary missed the QSST election?
• Outcome: Approved as inadvertent, conditioned on filing the QSST election within 120 days
• Key authorities: IRC §§ 1361 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: 202303002 Third Party Communication: None
Release Date: 1/20/2023 Date of Communication: Not Applicable
Index Number: 1361.00-00, 1362.00-00,
1362.04-00 Person To Contact:
--------------------------, ID No. ----------------
----------------------------- -----------------
------------------------------------------- Telephone Number:
---------------------- ---------------------
--------------------------- Refer Reply To:
---------------------------------- CC:PSI:B01
PLR-108609-22
Date:
October 24, 2022

                                              LEGEND

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

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

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

Trust = ------------------------------------------------------------------------------------------------
-------------------------

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

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

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

Date 4 = -----------------

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

    This letter responds to a letter dated April 20, 2022, and subsequent

correspondence, submitted on behalf of X by X’s authorized representative, requesting
relief under section 1362(f) of the Internal Revenue Code (the Code).

PLR-108609-22 2

                                      FACTS

   The information submitted states that X was incorporated under the laws of State

on Date 1 and elected to be an S corporation as of formation. On Date 2, A established
Trust, a revocable trust treated as a wholly-owned grantor trust under §§ 671 and 676,
and transferred shares of X to Trust as of Date 2.

    On Date 3, A died and Trust ceased to be a grantor trust with respect to A’s

interest, but Trust continued to qualify as an eligible S corporation shareholder under §
1361(c)(2)(A)(ii) for the 2 year period beginning on Date 3. X represents that Trust
qualified to elect to be treated as a qualified subchapter S trust (QSST). However, the
sole income beneficiary of Trust failed to make a timely QSST election within the
meaning of § 1361(d)(2), thereby causing X’s S corporation election to terminate on
Date 4.

   X represents that the circumstances resulting in the failure to file the QSST

election for Trust were inadvertent and not motivated by tax avoidance or retroactive tax
planning. X further represents that X has filed its income tax returns consistent with
having a valid S election in effect for all taxable years since X elected to be an S
corporation. X and its shareholders have agreed to make any adjustments consistent
with the treatment of X as an S corporation 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) 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 1
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 of an S corporation.

   Section 1361(c)(2)(A)(ii) provides that a trust may be an S corporation

shareholder if it was described in § 1361(c)(2)(A)(i) immediately before the death of the
deemed owner and it continues in existence after such death, but only for the 2-year
period beginning on the day of the deemed owner’s death.

PLR-108609-22 3

    Section 1361(d)(1) provides, in part, 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 the trust
is treated as the owner of that portion of the trust which consists of stock in a 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 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.

    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
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 the corporation was terminated under § 1362(d)(2) or (3) or § 1361(b)(3)(C); (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 such 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 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 termination, such corporation shall
be treated as an S corporation during the period specified by the Secretary.

PLR-108609-22 4

                                   CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

X’s S corporation election terminated on Date 4 when Trust became an ineligible
shareholder of X. We conclude that the termination was 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 beginning on and after Date 4, unless X’s S corporation election is
otherwise terminated under § 1362(d).

    This letter ruling is subject to the condition that within 120 days from the date of

this letter, the income beneficiary of Trust must file a QSST election effective Date 4
with the appropriate service center. 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 Trust’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.

   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__________
                                   Laura C. Fields
                                   Branch Chief, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosure:
Copy for § 6110 purposes

cc: