Late trust elections did not end S corporation status

Plain-English summary

An S corporation's shareholder died, and shares passed under the will to three trusts. Two trusts made qualified subchapter S trust elections even though they did not meet the QSST requirements, then failed to make timely electing small business trust elections when their temporary eligibility expired. A third trust qualified as a QSST until its income beneficiary died, remained temporarily eligible for two more years, and then also lacked a timely ESBT election. Those failures caused, or would have caused, the corporation's S election to terminate because the trusts became ineligible shareholders. The corporation represented that the mistakes were inadvertent, were not driven by tax avoidance or retroactive planning, and that all parties consistently filed as though S status and ESBT treatment continued. The IRS treated the S election as continuing under section 1362(f), conditioned on all three trustees filing retroactive ESBT elections within 120 days.

Ruling snapshot

• Question: Were the S corporation election terminations caused by the trusts' invalid or late shareholder elections inadvertent under IRC § 1362(f)?
• Outcome: Approved, conditioned on three ESBT elections being filed within 120 days
• Key authorities: IRC §§ 1361(c), 1361(d), 1361(e), and 1362(f); Treas. Reg. § 1.1361-1(j) and (m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202349006 Third Party Communication: None
Release Date: 12/8/2023 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.01-00,
1362.04-00 Person To Contact:
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----------------------------- Telephone Number:
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--------------------- Refer Reply To:
--------------------------- CC:PSI:3
------------------------------------ PLR-105558-23
Date:
September 13, 2023

Legend:

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

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

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

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

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

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

QTIP = --------------------------------------------
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Trust 1 = ------------------------------------------------------
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Trust 2 = ------------------------------------------------------------
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A = ---------------------------

B = ----------------------------
PLR-105558-23 2

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

    This letter responds to a letter dated March 7, 2023, and subsequent

correspondence, submitted on behalf of X by its authorized representatives, requesting
a ruling under § 1362(f) of the Internal Revenue Code (Code).

                                    FACTS

   According to the information submitted, X was incorporated under the laws of

State and elected to be an S corporation effective Date 1. A, a shareholder of X, died
and pursuant to A’s will shares of X stock were subsequently transferred to QTIP, Trust
1 and Trust 2.

    X represents that Trust 1 and Trust 2 qualified under § 1361(c)(2)(A)(iii) as

eligible S corporation shareholders for the two-year period ending Date 3. Effective
Date 2, both Trust 1 and Trust 2 elected to be treated as qualified subchapter S trusts
(QSSTs) under § 1361(d)(2), despite not meeting the requirements under § 1361(d)(3).
Consequently, X’s S corporation election terminated on Date 3 because the elections by
Trust 1 and Trust 2 to be treated as QSSTs were invalid. X represents that Trust 1 and
Trust 2 qualified as electing small business trusts (ESBTs) within the meaning of
§ 1361(e)(1)(A). However, the trustees of Trust 1 and Trust 2 failed to timely file
elections under § 1361(e)(3) to treat Trust 1 and Trust 2 as ESBTs.

   B, the sole income beneficiary of QTIP, elected to treat QTIP as a QSST under

§ 1361(d)(2). On Date 4, B died and QTIP ceased to qualify as a QSST. QTIP
remained an eligible S corporation shareholder of X for two years after the death of B,
until Date 5, at which time QTIP became an ineligible S corporation shareholder of X.
Consequently, X’s S corporation election would have terminated on Date 5, had it not
already terminated on Date 3. X represents that QTIP has at all times since Date 4 met
the requirements to be an ESBT within the meaning of § 1361(e)(1)(A), but the trustee
of QTIP failed to timely file an election under § 1361(e)(3) to treat QTIP as an ESBT.

    X 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. Further, X represents that it and its shareholders have always
filed tax returns consistent with X being an S corporation, Trust 1 and Trust 2 being
ESBTs effective Date 3, and QTIP being an ESBT effective Date 5. Finally, X and its
shareholders agree to make any adjustments consistent with the treatment of X as an S
corporation as may be required by the Secretary.
PLR-105558-23 3

                              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 the 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
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 an S
corporation shareholder.

   Section 1361(c)(2)(A)(ii) provides that for purposes of § 1361(b)(1)(B), a trust

which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed
owner and which continues in existence after such death may be an S corporation
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 two-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) — (A) such trust shall be treated as a
trust described in § 1361(c)(2)(A)(i), (B) for purposes of § 678(a), the beneficiary of s uch
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, and (C)
for purposes of applying §§ 465 and 469 to the beneficiary of the trust, the disposition of
the S corporation stock by the trust shall be treated as a disposition by such beneficiary.

  Section 1361(d)(2) 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
PLR-105558-23 4

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 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an ESBT

may be an S corporation shareholder.

   Section 1361(e)(1)(A) defines an ESBT as any trust if (i) such trust does not have

as a beneficiary any person other than (I) an individual, (II) an estate, (III) an
organization described in § 170(c)(2), (3), (4), or (5), or (IV) an organization described in
§ 170(c)(1) which holds a contingent interest in such trust and is not a potential current
beneficiary, (ii) no interest in such a trust was acquired by purchase, and (iii) an election
under § 1361(e) applies to such trust.

   Section 1361(e)(3) provides that an election under § 1361(e) shall be made by

the trustee. Any such election shall apply to the taxable year of the trust for which made
and all subsequent taxable years of such trust unless revoked with the consent of the
Secretary.

    Section 1.1361-1(j)(7)(ii) of the Income Tax Regulations provides that if, upon the

death of the QSST income beneficiary, the trust continues in existence and continues to
hold S corporation stock but no longer satisfies the QSST requirements, is not a grantor
trust or an ESBT, then, solely for purposes of § 1361(b)(1), as of the date of the income
beneficiary’s death, the estate of that income beneficiary is treated as the shareholder
of the S corporation for 2 years or until the transfer of the stock by the trust.

    Section 1.1361-1(m)(2)(i) provides that the trustee of an ESBT must make the

ESBT election by signing and filing, with the service center where the S corporation files
its income tax return, a statement that meets the requirements of § 1.1361-1(m)(2)(ii).

   Section 1.1361-1(m)(2)(iii) provides that the trustee of an ESBT must file the

ESBT election within the time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a
QSST election (generally within the 16-day-and-2-month period beginning on the day
that the stock is transferred to the trust).

   Section 1362(d)(2)(A) provides that an election under § 1362(a) will 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 terminated under § 1362(d)(2) or (3), (2) the Secretary
PLR-105558-23 5

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
the termination, steps were taken so that the corporation for which the termination
occurred is once more a small business corporation, and (4) the corporation for which
the termination occurred and each person who was a shareholder in the corporation at
any time during the period specified pursuant to § 1362(f), agrees to make adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to the period, then, notwithstanding the
circumstances resulting in the termination, the corporation will be treated as an S
corporation during the period specified by the Secretary.

                                  CONCLUSION

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

that X’s S corporation election terminated on Date 3 when Trust 1 and Trust 2 became
ineligible shareholders and would have terminated on Date 5 when QTIP became an
ineligible shareholder, had it not otherwise terminated on Date 3. We also conclude that
in both cases the circumstances resulting in the termination of X’s S corporation election
were inadvertent within the meaning of § 1362(f). Therefore, X will be treated as
continuing to be an S corporation effective Date 3 and thereafter, provided that X’s S
election was otherwise valid and has not otherwise terminated under § 1362(d).

   This ruling is conditioned on: (1) the trustees of Trust 1 and Trust 2 filing ESBT

elections for each respective trust, effective Date 3, with the appropriate service centers
within 120 days from the date of this letter, and (2) the trustee of QTIP filing an ESBT
election for QTIP, effective Date 5, with the appropriate service center within 120 days
from the date of this letter. A copy of this letter should be attached to the ESBT
elections.

     Except as expressly provided herein, we express or imply no opinion concerning

the tax consequences of any aspect of any transaction or item discussed or referenced
in this letter. Specifically, we express or imply no opinion regarding X’s eligibility to be
an S corporation, or Trust 1, Trust 2 or QTIP’s eligibility to be an ESBT.

   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.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.
PLR-105558-23 6

  In accordance with a power of attorney on file with this office, we are sending a

copy of this letter to X's authorized representatives.

                                            Sincerely,



                                            Robert D. Alinsky
                                            Branch Chief, Branch 3
                                            Office of Associate Chief Counsel
                                            (Passthroughs & Special Industries)

Enclosure:
Copy of letter for § 6110 purposes

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