Inadvertent Terminations

Internal Revenue Service
Number: 201613004
Release Date: 3/25/2016
Index Number: 1362.04-00
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LEGEND
Department of the Treasury
Washington, DC 20224
Third Party Communication:
None
Person To Contact:
---, ID No. ---
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Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-119516-15
Date:
November 23, 2015
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X =
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Y =
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A = ---
Date 1 = ---
State = ---
Date 2 = ---
Date 3 = ---
Date 4 = ---
Date 5 = ---
Date 6 = ---
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Trust =
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Dear ---:
This responds to a letter dated June 5, 2015, and supplemental information, submitted on behalf of X by X's authorized representative, requesting relief under section 1362(f) of the Internal Revenue Code (the Code).

# FACTS

According to the information submitted and representations made, X was incorporated on Date 1 and Y was incorporated on Date 2, both under the laws of State.
Effective Date 3, X elected to be taxed as an S corporation and to treat Y, its wholly owned subsidiary, as a qualified subchapter S subsidiary (QSub) under § 1361(b)(3) of the Code. Prior to Date 4, Trust was a grantor trust wholly owned by A and was an eligible shareholder of X. On Date 4, A died and Trust ceased being a grantor trust.
Trust qualified under § 1361(c)(2)(A)(ii) as an eligible shareholder for two years from A’s date of death. However, a timely election to treat Trust as an electing small business trust (“ESBT”) after this period was not made. Trust became an ineligible shareholder of X, causing X's S corporation election and Y’s QSub election to terminate, effective Date 5.
On Date 6, X redeemed all Trust’s shares of stock in X.
X represents that since Date 3, it has filed its federal income tax returns consistent with being an S corporation and has reported Y’s operations consistent with its QSub election. X represents that its S corporation election termination was inadvertent and was not motivated by tax avoidance or retroactive tax planning. Trust and X represent that Trust would have qualified as an ESBT since Date 5, and Trust has filed its returns consistent with being an ESBT. Further, X represents that X and its shareholders will make any adjustments required as a condition of obtaining relief under the inadvertent termination rule as provided under § 1362(f) of the Code that may be required by the Secretary.

# LAW AND ANALYSIS

Section 1361(a)(1) of the Code 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 1 class of stock.
PLR-119516-15 3
Section 1361(b)(3)(A) provides that a QSub shall not be treated as a separate corporation, and all assets, liabilities, and items of income, deduction, and credit of a QSub shall be treated as assets, liabilities, and such items (as the case may be) of the S corporation.
Section 1361(b)(3)(B) defines a “qualified subchapter S subsidiary” as a domestic corporation which is not an ineligible corporation, if 100 percent of the stock of the corporation is owned by the S corporation, and the S corporation elects to treat the corporation as a qualified subchapter S subsidiary.
Section 1361(c)(2)(A) provides, in relevant part, that, for purposes of
§ 1361(b)(1)(B), the following trusts may be shareholders of an S corporation: (i) a trust all of which is treated (under subpart E of part I of subchapter J of chapter 1) as owned by an individual who is a citizen or resident of the United States; (ii) a trust that was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed owner and which continues in existence after such death, but only for the 2-year period beginning on the day of the deemed owner’s death; and (iii) an ESBT.
Section 1361(e)(1)(A) provides that an ESBT means 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 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(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 election must be filed within the time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a qualified subchapter S trust 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.
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Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a) or § 1361(b)(3)(B)(ii) 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 such termination, steps were taken so that the corporation for which the termination occurred is a small business corporation; and (4) the corporation for which 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 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 and Y’s QSub election inadvertently terminated within the meaning of § 1362(f) on Date 5 due to the trustee’s failure to make an ESBT election for Trust. Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation and Y will be treated as continuing to be a QSub from Date 5 and thereafter, provided X's S corporation election and Y’s QSub election were otherwise valid and have not otherwise terminated under § 1362(d).
This ruling is contingent upon, within 120 days from the date of this letter, the trustee filing with the appropriate service center an election to treat Trust as an ESBT effective Date 5. A copy of this letter should be attached to the ESBT election.
Except as specifically ruled upon 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, Y’s ability to be a QSub, or Trust’s eligibility to be an ESBT.
This ruling is directed only to the taxpayer that requested it. According to
§ 6110(k)(3), this ruling may not be used or cited as precedent.
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Pursuant to the power of attorney on file with this office, we are sending a copy of this letter to your authorized representatives.
Enclosures (2)
Copy of this letter
Copy for § 6110 purposes
Sincerely,
Holly Porter
Branch Chief, Branch 3
Associate Chief Counsel
(Passthroughs and Special Industries)