Inadvertent Terminations

Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 202416004
Release Date: 4/19/2024
Index Number: 1362.04-00
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In Re: Private Letter Ruling Request
Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B01
PLR-114403-23
Date:
January 08, 2024
LEGEND
X = ---
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Trust = ---
Share B = ---
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A = ---
B = ---
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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 cc: ---
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