S corporation's accidental termination is excused when a trust missed its QSST election

Plain-English summary

An S corporation is a small business corporation whose income is taxed to its shareholders rather than the company, but it can only have certain kinds of shareholders. A trust can qualify, but only if it fits a specific category, and for a "qualified subchapter S trust" (QSST) the income beneficiary must file a QSST election. Here a married couple held their S corporation shares through a revocable living trust (an eligible shareholder). When one spouse died, the trust split into two trusts. One of them (Trust 3) met every requirement to be a QSST except that the beneficiary never filed the required QSST election, which meant the corporation had an ineligible shareholder and its S election was accidentally terminated. The corporation asked the IRS for relief under section 1362(f), which lets the IRS ignore an inadvertent termination if the problem is fixed within a reasonable time and everyone agrees to consistent tax treatment. The IRS found the termination was inadvertent and ruled the company will continue to be treated as an S corporation without interruption, on the condition that the trustee files the missing QSST election (effective from the date of the trust division) within 120 days. This is a common fix for an S corporation that slipped out of status because of a missed trust election.

Ruling snapshot

• Question: Was the termination of the company's S corporation election (caused by a trust's failure to make a QSST election) inadvertent, so the company can keep S corporation status under § 1362(f)?
• Outcome: Approved (inadvertent termination excused, conditioned on filing the QSST election within 120 days)
• Key authorities: IRC §§ 1361(b), 1361(c)(2), 1361(d), 1362(a), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(j)(6)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202507006 Third Party Communication: None
Release Date: 2/14/2025 Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.03-00,
Person To Contact:
1361.03-03, 1362.04-00
--------------------, ID No. -----------------

                                                            Telephone Number:

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                                                            Refer Reply To:

------------------------ CC:PSI:01
--------------------------- PLR-109672-24
Date:
November 19, 2024

                                                 LEGEND

X = ---------------------------------------------------------------------------------------
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A = ---------------------------------------------------------------------------------------
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B = ---------------------------------------------------------------------------------------
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Trust 1 = ---------------------------------------------------------------------------------------
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Trust 2 = ---------------------------------------------------------------------------------------
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Trust 3 = ---------------------------------------------------------------------------------------
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State = -------------

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

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

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

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

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

Date 6 = -------------------

Dear -------------------

This letter responds to a letter dated May 10, 2024, and subsequent correspondence,
submitted on behalf of X by X's authorized representative, requesting a ruling under
§ 1362(f) of the Internal Revenue Code (Code).

                                                FACTS

According to the information submitted, X was organized as a corporation under the
laws of State on Date 1 and elected to be treated as an S corporation effective Date 5.
On Date 2, spouses A and B established Trust 1, a revocable living trust that was
treated under subpart E of part I of subchapter J of chapter 1 of the Code as entirely
owned by A and B and, thus, was an eligible S corporation shareholder under
§ 1361(c)(2)(A)(i). A and B contributed their shares of X to Trust 1 on Date 3. On Date
4, B died. Relative to B's shares of X stock, Trust 1 continued to be an eligible S
corporation shareholder for 2 years beginning on Date 4 under § 1361(c)(2)(A)(ii). The
trust agreement provided that, on the death of either A or B, Trust 1 would be divided
into Trust 2 and Trust 3 and directed the trustee to transfer the assets of Trust 1 to Trust
2 and Trust 3. On Date 6, A completed the division of Trust 1 into Trust 2 and Trust 3 by
allocating the shares of X held by Trust 1 to Trust 2 and Trust 3.

X represents that Trust 2 is treated under subpart E of Part I of subchapter J of chapter
1 of the Code as entirely owned by A and thus is a permissible shareholder under
§ 1361(c)(2)(A)(i). X represents that Trust 3 meets the requirements to be treated as a
qualified subchapter S trust (QSST) as described in §1361(d), except that A failed to
make the election under § 1361(d)(2).

X represents that X and X's shareholders have filed tax returns consistent with X being
an S corporation. X also represents that all of the income with respect to the stock of X
held by Trust 3 has been consistently reported by A on A's individual federal tax returns
as if the QSST election for Trust 3 had been in effect since Date 6. X further represents
that the circumstances resulting in the termination of X's S corporation election were
inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and
each person who was or is a shareholder of X at any time since Date 6 agree to make
any adjustments (consistent with the treatment of X as an S corporation) as may be
required by the Secretary with respect to such period.

                              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) 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(d)(1) provides, in part, 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 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 (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 1.1361-1(j)(6)(ii) provides that the current income beneficiary of a QSST must
make the election by signing and filing, with the service center with which the S
corporation files its income tax return, the applicable form or a statement that includes
the information listed in § 1.1361-1(j)(6)(ii).

Section 1.361-1(j)(6)(iii) provides, in part, that a QSST election must be filed within the
time requirements of § 1.1361-1(j)(6)(iii)(A) through (D).

Section 1362(a) provides that a small business corporation may elect to be an S
corporation.

Section 1362(d)(2)(A) provides that an S corporation election 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 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
was terminated under § 1362(d)(2) or (3); (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; 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 facts submitted and the representations made, we conclude that X's
S corporation election terminated on Date 6 resulting from the failure of A, as the
beneficiary of Trust 3, to make the election under § 1361(d)(2).

We further conclude that the circumstances resulting in the termination of X's S
corporation election were inadvertent within the meaning of § 1362(f). Therefore, under
§ 1362(f), X will continue to be treated as an S corporation from Date 6 and thereafter,
provided that X's S corporation election was valid and has not otherwise terminated
under § 1362(d) for reasons not addressed in this letter.

This ruling is conditioned on the trustee of Trust 3 filing an QSST election for Trust 3
effective Date 6 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 specifically ruled on above, we express or imply no opinion concerning the
federal tax 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 and Trust 3's eligibility to be a QSST.

The ruling contained in this letter is based on 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 requested ruling, 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 your authorized representatives.

                                                           Sincerely,

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

Enclosure
Copy for § 6110 purposes

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