Late QSST election did not terminate S corporation status

Plain-English summary

An S corporation's stock was held by a grantor trust until the grantor died. The trust agreement then required separate shares, including one for an individual beneficiary that qualified as a separate share under Section 663(c) and was represented to meet the qualified subchapter S trust requirements. The beneficiary failed to timely elect QSST treatment, making the share an ineligible shareholder and terminating the corporation's S election. The corporation and shareholders represented that the lapse was inadvertent, not tax-motivated, and that they had consistently filed as though S and QSST status continued. The IRS granted Section 1362(f) relief, treating the corporation as continuously eligible and the separate share as a QSST from the grantor's death, provided the beneficiary files the QSST election within 120 days. The ruling did not decide whether the corporation or trust share otherwise met the applicable requirements.

Ruling snapshot

• Question: Was the S corporation election's termination from the beneficiary's failure to timely elect QSST treatment inadvertent under Section 1362(f)?
• Outcome: approved, subject to filing the QSST election within 120 days
• Key authorities: IRC §§ 663(c), 1361(c)-(d), 1362(d), 1362(f); Treas. Reg. §§ 1.663(c)-1, 1.663(c)-3, 1.1361-1(j)

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202416004                                             Third Party Communication: None
 Release Date: 4/19/2024                                       Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                               Person To Contact:
 ------------------------------------------------              -------------------------, ID No. -----------------
 ------------------------------------------                    -----------------------------------------------------
 ------------------                                            Telephone Number:
 -------------------------                                     --------------------
 -----------------------------------------------------------   Refer Reply To:
                                                               CC:PSI:B01
 In Re: Private Letter Ruling Request                          PLR-114403-23
                                                               Date:
                                                               January 08, 2024




                                                    LEGEND

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

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

 Share B            =    -----------------------------------------------------------------------------------------
                         -------------------------------

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

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

 State              =    ------

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

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



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

This letter responds to a letter dated May 11, 2023, and subsequent correspondence,
submitted on behalf of X by its authorized representatives, requesting relief under
§ 1362(f) of the Internal Revenue Code (Code).
PLR-114403-23                                2

                                         FACTS

According to the information submitted and representations within, X was incorporated
under the laws of State and filed an election under § 1362(a) of the Code to be treated
as an S corporation effective Date 1.

Prior to A’s death, shares of X stock were held by Trust. Trust was treated (under
subpart E of part I of subchapter J of chapter 1 of the Code) as a grantor trust owned by
A, an individual, until Date 2 when A died and Trust ceased to qualify as a shareholder
under § 1361(c)(2)(A)(i).

Under the terms of the Trust agreement, upon A’s death, the trustees were required to
create separate shares within Trust, including a separate share for the benefit of B, an
individual (Share B). Share B is treated as a separate share under § 663(c).

X represents that Share B met the requirements of a qualified subchapter S trust
(QSST) within the meaning of § 1361(d)(3). However, B, the income beneficiary of
Share B, failed to timely make an election under § 1361(d)(2) to treat Share B as a
QSST. Consequently, Share B was an ineligible shareholder of X, and X's S corporation
status terminated on Date 2. Nevertheless, X represents that B has filed federal income
tax returns consistent with having valid a QSST election in effect for Share B since Date
2.

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.

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
PLR-114403-23                                 3

owned by an individual who is a citizen or resident of the United States may be a
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 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)(2)(B)(ii) provides that if a QSST election is made with respect to any
beneficiary, an election under this paragraph shall be treated as made by each
successive beneficiary unless such beneficiary affirmatively refuses to consent to such
election.

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 1361(d)(3) further provides that 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) and (c).

Section 663(c) provides that for the sole purpose of determining the amount of
distributable net income in the application of §§ 661 and 662, in the case of a single
trust having more than one beneficiary, substantially separate and independent shares
of different beneficiaries in the trust shall be treated as separate trusts. The existence of
such substantially separate and independent shares and the manner of treatment as
separate trusts, including the application of subpart D, shall be determined in
accordance with regulations prescribed by the Secretary.

Section 1.663(c)-1(a) of the Income Tax Regulations provides that if a single trust has
more than one beneficiary, and if different beneficiaries have substantially separate and
independent shares, their shares are treated as separate trusts for the sole purpose of
determining the amount of distributable net income allocable to the respective
beneficiaries under §§ 661 and 662 (the separate share rule). The regulations further
provide, in § 1.663(c)-1(c), that the separate share rule may be applicable even though
PLR-114403-23                                 4

separate and independent accounts are not maintained and are not required to be
maintained for each share on the books of account of the trust, and even though no
physical segregation of assets is made or required. Section 1.663(c)-3(a) provides that
the applicability of the separate share rule generally depends on whether trust
distributions are to be made in substantially the same manner as if separate trusts had
been created.

Section 1.1361-1(j)(7)(i) 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
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.
PLR-114403-23                                5

                                     CONCLUSION

Based solely on the information submitted and the representations made, we conclude
that X's S corporation election terminated on Date 2, when Share B 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 beginning on and after Date 2, unless X's S corporation election is
otherwise terminated under § 1362(d).

We further conclude that Share B will be treated as a QSST from Date 2 and thereafter
provided B files a QSST election for Share B effective Date 2 with the appropriate
service center within 120 days of this ruling. A copy of this letter should be attached to
the QSST election.

Except as specifically ruled 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 whether X is otherwise
eligible to be an S corporation or whether Share B is otherwise eligible 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 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.
PLR-114403-23                                            6


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,

                                                   Holly Porter
                                                   Associate Chief Counsel
                                                   (Passthroughs & Special Industries)



                                             By:
                                                   Jennifer Kenney
                                                   Senior Counsel, Branch 1
                                                   Office of Associate Chief Counsel
                                                   (Passthroughs & Special Industries)

Enclosure
      Copy for § 6110 purposes




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