S status restored after testamentary trust deadline

Plain-English summary

An estate transferred S corporation shares to a trust under a will. The trust could remain an eligible S corporation shareholder for two years after the transfer, and it otherwise met the requirements of a qualified subchapter S trust. When the two-year period ended, however, the income beneficiary had not filed a QSST election, making the trust ineligible and terminating the corporation's S election. The IRS found the termination inadvertent and allowed S status to continue from the termination date. Relief is contingent on the beneficiary filing a retroactive QSST election within 120 days, or the ruling becomes void and the corporation must notify its service center of the termination.

Ruling snapshot

• Question: Could the corporation retain S status after a testamentary trust missed the QSST election when its two-year eligibility ended?
• Outcome: Approved, subject to a retroactive QSST election within 120 days
• Key authorities: IRC §§ 1361(c)(2), 1361(d), 1362(d), 1362(f); Treas. Reg. § 1.1361-1(j)(7)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202344005                                              Third Party Communication: None
Release Date: 11/3/2023                                        Date of Communication: Not Applicable
Index Number: 1361.03-00, 1361.03-02,
              1362.00-00, 1362.04-00                           Person To Contact:
                                                               -------------------, ID No. -----------------
---------------------------------------------------            Telephone Number:
------------------------------------------------------------   --------------------
-------------------------                                      Refer Reply To:
-----------------------------------------                      CC:PSI:01
--------------------------------------                         PLR-102823-23
                                                               Date:
                                                               August 03, 2023




                                                   LEGEND


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

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

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

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

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

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

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

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

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

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

PLR-102823-23                                 2


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

This responds to a letter dated January 27, 2023, and subsequent correspondence,
submitted on behalf of X by X's authorized representatives, 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 Date 1. X filed an election under § 1362(a) of the Code to be
treated as an S corporation effective Date 2.

A, an individual, owned shares of X stock and died on Date 3. On Date 4, A's estate
transferred shares of X stock to Trust pursuant to the terms of A's will. Trust qualified
as an eligible S corporation shareholder for the two-year period beginning on the day
the shares of X stock were transferred to it and ending Date 5 under
§ 1361(c)(2)(A)(iii).

X represents that Trust met the requirements of a qualified subchapter S trust (QSST)
within the meaning of § 1361(d)(3). However, B, the income beneficiary of Trust, failed
to timely make an election under § 1361(d)(2) to treat Trust as a QSST.
Consequently, Trust was an ineligible shareholder of X and X's S corporation status was
terminated on Date 5.

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

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.

PLR-102823-23                                 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)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust may be a
shareholder with respect to stock transferred to it pursuant to the terms of a will, 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.

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

PLR-102823-23                                 4

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 Date 5, when Trust became an ineligible
shareholder.

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 Date 5, 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.

This ruling is contingent on B filing a QSST election for Trust effective Date 5 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. 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 Date 5.

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

PLR-102823-23                                  5

corporation. In addition, we express or imply no opinion as to whether Trust is eligible
to elect to be treated as a QSST.

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.

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


                                  Sincerely,



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



Enclosure
      Copy of this letter for section 6110 purposes



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