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

Plain-English summary

An S corporation's shares were held by a grantor trust that later stopped qualifying as an eligible S corporation shareholder. The shares were transferred to another trust that could qualify as a qualified subchapter S trust, but the income beneficiary did not timely make the QSST election. That failure technically terminated the corporation's S election. The IRS found the termination inadvertent because it was not motivated by tax avoidance or retroactive tax planning and the parties had consistently filed as though the corporation and trust remained eligible. It treated the corporation as continuously maintaining S status, provided the beneficiary filed the QSST election within 120 days and the S election was otherwise valid.

Ruling snapshot

• Question: Could the corporation keep its S status after a trust beneficiary failed to timely elect QSST treatment?
• Outcome: approved, continuous S status conditioned on a QSST election within 120 days
• Key authorities: IRC §§ 1361(c), 1361(d), 1362(d), and 1362(f)

Full text (IRS public release)

 Internal Revenue Service                                  Department of the Treasury
                                                           Washington, DC 20224

 Number: 202401004                                         [Third Party Communication:
 Release Date: 1/5/2024                                    Date of Communication: Month DD, YYYY]
 Index Number: 1362.00-00, 1362.01-00,
               1362.04-00                                  Person To Contact:
                                                           -----------------------, ID No. -----------------
 ----------------                                          Telephone Number:
 -------------------------------------------               --------------------
 ------------------                                        Refer Reply To:
 -------------------------------                           CC:PSI:3
 -----------------------------------                       PLR-107811-23
                                                           Date:
                                                           October 06, 2023




Legend:

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

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

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

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

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

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

 Trust 1 = ---------------------------------------------
           -----------------------

 Trust 2 = ----------------------------------------------------------------------------
           -
           -----------------------

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




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

PLR-107811-23                                 2

        This letter responds to a letter dated March 23, 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 on Date 1 and elected to be an S corporation effective Date 2. On Date 3, Trust 1
was formed and subsequently became a shareholder of X.

        X represents that Trust 1 was a grantor trust and eligible S corporation
shareholder under § 1361(c)(2)(A)(i) at all times since it first acquired shares of X until
Date 4, at which point Trust 1 no longer qualified as an eligible S corporation
shareholder under § 1361(c)(2)(A)(i). On Date 4, the shares of X held by Trust 1 were
transferred to Trust 2. X represents that Trust 2 was eligible to elect to be treated as a
qualified subchapter S trust (QSST) under § 1361(d). However, A, Trust 2’s income
beneficiary, failed to make an election under § 1361(d)(2) to treat Trust 2 as a QSST
effective Date 4. Therefore, X’s S election terminated on Date 4.

       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 since inception X and its
shareholders have filed tax returns consistent with X being an S corporation, and Trust
2 being a QSST since Date 4. 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.

                                  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.

PLR-107811-23                                 3

        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 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, 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
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 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
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.

PLR-107811-23                                 4

                                      CONCLUSION

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date 4 when Trust 2 became an ineligible
shareholder. We also conclude that 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 from Date 4 and thereafter,
provided that X’s S election was otherwise valid and was not otherwise terminated
under § 1362(d).

        This ruling is contingent on A filing a QSST election for Trust 2 effective Date 4,
with the appropriate service center within 120 days from the date of this letter. A copy
of this letter should be attached to the QSST election.

         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 2’s eligibility to be 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 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.

      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

PLR-107811-23   5



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