Late QSST election preserves S corporation status

Plain-English summary

An S corporation issued shares to a trust that qualified to be a qualified subchapter S trust, but the trust beneficiary did not timely make the QSST election. The trust and beneficiary nevertheless filed consistently with QSST treatment, and the corporation continued filing as an S corporation. Because the trust was technically an ineligible shareholder without the election, the corporation's S status terminated on the stock-transfer date. The IRS found the termination inadvertent and treated the corporation as continuously maintaining S status. The relief is conditioned on the beneficiary filing a retroactive QSST election within 120 days and attaching the ruling.

Ruling snapshot

• Question: Can the corporation retain continuous S status after a beneficiary misses the QSST election for a shareholder trust?
• Outcome: Approved, if the beneficiary files the QSST election within 120 days
• Key authorities: IRC §§ 1361(c), 1361(d), 1362(d), and 1362(f); Treas. Reg. § 1.1361-1(j)(7)(i)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202315004                                             Third Party Communication: None
Release Date: 4/14/2023                                       Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.03-02,
              1362.00-00, 1362.02-00,                         Person To Contact:
              1362.04-00                                      --------------------, ID No. -----------------
                                                              Telephone Number:
-------------------------------------                         --------------------
---------------------------------------------                 Refer Reply To:
---------------------                                         CC:PSI:B01
------------------------------                                PLR-113904-22
--------------------------------                              Date:
                                                              January 13, 2023




                                                   Legend

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

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

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

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

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

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

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

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

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

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

Trust        =    -----------------------------------------------------------------------------------------------
                  ------------------------
PLR-113904-22                                 2



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

This letter responds to a letter dated July 20, 2022, submitted on behalf of X by its
authorized representatives, requesting inadvertent termination relief under § 1362(f) of
the Internal Revenue Code (Code).
                                            Facts

X was organized on Date 1, under the laws of State. Effective Date 1, X elected to be
taxed as an S corporation.

On Date 2, A and B established Trust for the benefit of C. On Date 3, shares of X were
issued to Trust. Trust remained a shareholder until Date 4. X represents that Trust was
eligible to be a qualified subchapter S trust (QSST) under § 1361(c)(2)(A)(i); however, the
beneficiary of Trust failed timely to file such a QSST election.

X represents that the failure to file the QSST election for Trust was inadvertent and not
motivated by tax avoidance or retroactive tax planning. X further represents that: (1) X
has filed its income tax returns consistent with having a valid S corporation election in
effect for all taxable years since X elected to be an S corporation; (2) Trust continuously
qualified as a QSST from Date 3 through Date 4, and has filed all relevant U.S. federal
income tax returns on a basis consistent with having a valid QSST election in effect as of
Date 3; (3) C has filed C’s federal income tax returns for all relevant periods on a basis
consistent with Trust having a valid QSST election in effect as of Date 3; and (4) X has
continuously qualified as a small business corporation from Date 1 until Date 5. X and its
shareholders have agreed to make such 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) 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) 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) as owned by an individual who is a
citizen or resident of the United States may be a shareholder of an S corporation.
PLR-113904-22                                  3

Section 1361(d)(1) provides, in pertinent 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 an S
corporation with respect to which the election under § 1361(d)(2) is made.

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 be only 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 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 1 individual who is a citizen
or resident of the United States. A substantially separate and independent share of a
trust 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(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 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 § 1362(d)(2) or (3); (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-113904-22                                 4

                                        Conclusion

Based solely on the information submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 3, when Trust became an ineligible
shareholder. We also conclude that the termination of X’s S corporation election on
Date 3 was inadvertent within the meaning of § 1362(f). Accordingly, under § 1362(f), X
will be treated as continuing to be an S corporation on and after Date 3, provided that X’s
S corporation election was valid and not otherwise terminated under § 1362(d).

This ruling is contingent upon C, as the beneficiary of Trust, filing a QSST election for
Trust within 120 days of the date of this letter 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 whether Trust was or is otherwise a valid QSST.

This ruling is directed only to the taxpayer who 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/
                                       _______________________________
                                       Caroline E. Hay
                                       Senior Technician Reviewer, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)


Enclosure

       Copy for § 6110 purposes
PLR-113904-22   5


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