Inadvertent S-corp termination relief after a trust missed its QSST election following the owner's death

Plain-English summary

A corporation was taxed as an S corporation, which passes income through to
eligible shareholders. One shareholder held his stock through a grantor trust
(treated as owned by him, so it was a permitted shareholder). When he died, the
trust could keep holding the S stock, but only for a limited time: the tax rules
give a deceased grantor's trust a two-year grace period, after which the trust
must qualify some other way, such as the beneficiary electing "qualified
subchapter S trust" (QSST) treatment. The beneficiary never made the QSST
election in time, so when the grace period ended the corporation's S election
automatically terminated. The company asked the IRS to treat the termination as
inadvertent under Code § 1362(f). The IRS agreed, finding no tax avoidance, and
restored S status, conditioned on the beneficiary filing the QSST election within
120 days. This matters because the death of an S-corporation shareholder starts a
clock on trust elections, and missing it can accidentally end S status, which
§ 1362(f) can cure.

Ruling snapshot

• Question: Was the termination of a company's S election, caused by a trust's failure to make a timely QSST election after the deemed owner's death, inadvertent so that S status can be restored?
• Outcome: approved (inadvertent termination relief granted, contingent on filing the QSST election within 120 days)
• Key authorities: IRC § 1362(f); IRC § 1361(c)(2), (d); IRC § 645

Full text (IRS public release)

 Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202317014                                            Third Party Communication: None
 Release Date: 4/28/2023                                      Date of Communication: Not Applicable
 Index Number: 1361.03-00, 1361.03-01,
               1361.03-02, 1362.00-00,                        Person To Contact:
               1362.01-00, 1362.02-00,                        ------------------------, ID No. ------------------
               1362.02-02, 1362.04-00                         ----------------------------------------------------
                                                              Telephone Number:
 ----------------------------------------                     --------------------
 --------------------------                                   Refer Reply To:
 ----------------------------------                           CC:PSI:B01
 -----------------------------                                PLR-117052-22
 --------------------------------------                       Date:
                                                              January 25, 2023




Legend

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

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

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

 a              = -------------

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

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

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

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

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

 Date 6         = -------------------------

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


Dear ---------------:
PLR-117052-22                                2


This letter responds to a letter dated September 1, 2022, and subsequent
correspondence, submitted on behalf of X, by X’s authorized representative, requesting
relief under § 1362(f) of the Internal Revenue Code.

                                         FACTS

According to the information submitted, X was incorporated under the laws of State on
Date 1 and elected to be treated as an S corporation effective Date 2. Trust was formed
on Date 3 with A as grantor and settlor. Trust was treated as a grantor trust until Date 4,
when A died. At the time of A’s death on Date 4, A held a% of stock in X.

An election was made under § 645 to treat Trust as part of A’s estate on Date 4. A’s
shares of X stock were transferred to Trust on Date 5. However, the beneficiary of Trust
failed to timely make a Qualified Subchapter S Trust (QSST) election. The § 645
election terminated on Date 5, which is before Date 6, the last day of the 2-year period
beginning on the day of A’s death.

X represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent and not motivated by tax avoidance or retroactive tax
planning. Additionally, X represents that X and its shareholders have filed their federal
income tax returns consistent with having a valid S corporation election in effect for X. 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 with respect to
the period specified by § 1362(f).

                                  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) 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.
PLR-117052-22                                 3

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(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) 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
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 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.
PLR-117052-22                                  4

                                      CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X’s S
corporation election terminated on Date 6. We further conclude that the termination was
inadvertent within the meaning of § 1362(f). Accordingly, X will be treated as continuing
to be an S corporation from Date 6, and thereafter, provided that its S corporation
election was otherwise valid and was not otherwise terminated under § 1362(d).

This ruling is contingent upon the beneficiaries of Trust filing a QSST election, with an
effective date of Date 6, 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 expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, no opinion is expressed or implied concerning the eligibility of X
to be an S corporation.

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 X's authorized representative.

                                       Sincerely,


                                       _______________________________
                                       Joy Spies, Senior Technician Reviewer
                                       Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)



Enclosure
      Copy for § 6110 purposes


cc: