Missing elections for nine trusts caused only an inadvertent S termination

Plain-English summary

After a shareholder died, an original trust covered by a Section 645 election
transferred its S-corporation shares to nine successor trusts. Eight were
intended to be qualified subchapter S trusts and one was intended to be an
electing small business trust, but the beneficiaries and trustee did not make
valid elections. The resulting ineligible shareholders technically terminated
the corporation's S status. The IRS found the termination inadvertent because
the parties consistently treated the trusts and corporation as eligible and
represented that no tax avoidance or retroactive planning was involved. S
status continued, conditioned on filing all eight QSST elections and the ESBT
election within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status despite missing QSST and ESBT elections for nine successor trusts?
• Outcome: Approved as an inadvertent termination, conditioned on filing the elections within 120 days
• Key authorities: IRC §§ 645, 1361(c)-(e), and 1362(f); Treas. Reg. §§ 1.645(b)-1 and 1.1361-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202407005 Third Party Communication: None
Release Date: 2/16/2024 Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.03-00,
1361.03-02, 1361.03-03, Person To Contact:
1362.00-00, 1362.04-00 ------------------------------, ID No. ------------
---------------
---------------------------------- Telephone Number:
-------------------------------------- --------------------
------------------------------------- Refer Reply To:
--------------------------------- CC:PSI:B01
--------------------------------- PLR-117761-23
Date:
November 16, 2023

X = --------------------------------------
EIN: ----------------

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

Original Trust = --------------------------------------------------------

Trust 1 = -----------------------------------------------------------------------
EIN: ----------------

Trust 2 = --------------------------------------------------------------------------
EIN: ----------------

Trust 3 = ------------------------------------------------------------------------
EIN: ----------------

Trust 4 = -------------------------------------------------------------------------------
EIN: ----------------

Trust 5 = ------------------------------------------------------------------------
EIN: ----------------

Trust 6 = --------------------------------------------------------------------
EIN: ----------------

Trust 7 = ---------------------------------------------------------------------------
EIN: ----------------
PLR-117761-23 2

Trust 8 = ---------------------------------------------------------------------------
EIN: ----------------

Trust 9 = -----------------------------------------------------------------------------------
EIN: ----------------

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

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

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

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

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

This letter responds to a letter dated August 4, 2023 and subsequent correspondence
submitted on behalf of X by its authorized representative requesting a ruling under
§ 1362(f) of the Internal Revenue Code (Code).

                                               FACTS

The information submitted states that X was incorporated under the laws of State on
Date 1 and made a valid S corporation election effective as of formation.

A, an individual and eligible shareholder owned shares of X. During A’s lifetime, A
transferred the shares of X to Original Trust. Original Trust was treated as an eligible
shareholder of X under § 1361(c)(2)(A)(i). On Date 2, A died.

An election under § 645 was made to treat Original Trust as part of A’s estate for federal
tax purposes. Therefore, Original Trust remained an eligible shareholder of X until Date
3.

On Date 3, Original Trust transferred all its shares of X to Trust 1, Trust 2, Trust 3, Trust
4, Trust 5, Trust 6, Trust 7, Trust 8, and Trust 9. Each of Trust 1 through Trust 9, was an
eligible Qualified Subchapter S Trust (QSST) or Electing Small Business Trust (ESBT),
as applicable.

Although it was intended that Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6, Trust 7,
and Trust 8 be QSSTs, the income beneficiary of each of Trust 1 through Trust 8 failed
to make a valid QSST election. It was intended that Trust 9 be an ESBT; however, the
trustee of Trust 9 failed to make a valid ESBT election. Therefore, each of Trust 1
through Trust 9 became an ineligible shareholder of X as of Date 3 thereby causing X’s
S corporation election to terminate as of Date 3.
PLR-117761-23 3

X represents that there was no tax avoidance or retroactive tax planning involved in
failing to file the QSST elections or the ESBT election and the resulting termination of
X’s S corporation election was inadvertent. X and its shareholders agree to make any
adjustments that the Secretary may require as a condition of obtaining relief under the
inadvertent termination rule as provided under § 1362(f) of the Code. X also represents
that Trust 1 through Trust 8 qualify as QSSTs as of Date 3 and have consistently been
treated as QSSTs, Trust 9 qualifies as an ESBT as of Date 3 and has consistently been
treated as an ESBT, and X has qualified as an S corporation and has been consistently
treated as an S corporation as of Date 1.

                              LAW AND ANALYSIS

Section 645(a) provides that if both the executor of an estate and the trustee of a
qualified revocable trust elect the treatment provided in this section, such trust shall be
treated and taxed as part of such estate (and not as a separate trust) for all taxable
years of the estate ending after the date of the decedent’s death and before the
applicable date.

Section 645(b)(2) provides that the term “applicable date” means (A) if no return of tax
imposed by chapter 11 is required to be filed the date which is 2 years after the date of
the decedent’s death and (B) if such return is required to be filed, the date which is 6
months after the date of the final determination of the liability for tax imposed by chapter
11.

Section 1.645(b)(1) provides, in part, that a qualified revocable trust is any trust (or
portion thereof) that on the date of death of the decedent was treated as owned by the
decedent under § 676 by reason of a power held by the decedent (determined without
regard to § 672(e)). A trust that was treated as owned by the decedent under § 676 by
reason of a power that was exercisable by the decedent only with the approval or
consent of a nonadverse party or with the approval or consent of the decedent’s spouse
is a QRT. A trust that was treated as owned by the decedent under § 676 solely by
reason of a power held by a nonadverse party or by reason of a power held by the
decedent’s spouse is not a QRT.

Section 1.645(b)(2) provides that an electing trust is a QRT for which a valid § 645
election has been made. Once a § 645 election has been made for the trust, the trust
shall be treated as an electing trust throughout the entire election period.

Section 1361(a)(1) of the Code provides that the term S Corporation means, with
respect to a taxable year, a small business corporation for which an election under
§ 1362(a) is in effect for such taxable 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,
PLR-117761-23 4

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 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) as owned by an individual who is a citizen or resident
of the United States may be a shareholder of an S corporation.

Section 1361(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B), an ESBT is a
permissible shareholder.

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 the trust
is treated as the owner of the 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 one income beneficiary of the trust, (ii) any corpus distributed during
the life of the current income beneficiary may be distributed only to such a 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. 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 1361(e)(1)(A) provides that, for purposes of § 1361, except as provided in
§ 1361(e)(1)(B), the term “electing small business trust” means any trust where (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)-(5), or (IV) an organization
described in § 170(c)(1) which holds a contingent interest in such trust and is a potential
current beneficiary, (ii) no interest in such 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
subsequent taxable year of such trust unless revoked with the consent of the Secretary.

Section 1.1361-1(j)(6)(ii) provides that the beneficiary of a QSST must make the QSST
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(j)(6)(ii).
PLR-117761-23 5

Section 1.1361-1(j)(6)(iii) provides that the QSST election must be made within the 16-
day-and-2 month period beginning on the day that the stock is transferred to the trust.

Section 1.1361-1(m)(2)(i) provides, in part, 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)(ii) provides that the ESBT election must be filed within the time
requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a QSST election.

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 1st 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 not effective for the taxable year for which made (determined without
regard to § 1362(b)(2)(b)) 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 of termination, such corporation shall be
treated as an S corporation during the period specified by the Secretary.

                                  CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X’s S
corporation election terminated on Date 3 because no valid QSST elections were made
for Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6, Trust 7 and Trust 8, and no valid
ESBT election was made for Trust 9. We further conclude that the termination of X’s S
corporation status on Date 3 was inadvertent within the meaning of § 1362(f).
Accordingly, X will be treated as an S corporation effective Date 3, and thereafter,
provided that X’s S corporation election was otherwise valid and was not otherwise
terminated under § 1362(d). This ruling is contingent upon the filing of QSST elections
for each of Trust 1 through Trust 8, and the filing of an ESBT election for Trust 9,
PLR-117761-23 6

respectively, within 120 days of the date of this letter. A copy of this letter should be
attached to each QSST and ESBT election.

Except as specifically ruled upon above, we express or imply no opinion concerning the
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, Trust 1 through Trust 8’s eligibility to be QSSTs, or Trust 9’s eligibility to be
an ESBT.

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,


                                               _/s/_________________________
                                               Darshan H. Chulani
                                               Senior Counsel, Branch 1
                                               Office of the Associate Chief Counsel
                                               (Passthroughs & Special Industries)

Enclosure
Copy for § 6110 purposes
PLR-117761-23 7

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