Although we don’t for sure how the issue managed to slip through the cracks, many advisers will have sympathy for the situation that gave rise to the need to request late QSST election relief and treatment of termination of S status as inadvertent in PLR 201618003
In the situation in question an existing S corporation had among its shareholders two trusts, each of which had timely an election to be a qualifying Subchapter S trust (QSST)under IRC §1361(d)(2).
Eventually the original S corporation was acquired in what appears to have been a tax free reorganization under IRC §368(a) (that fact isn’t specifically mentioned in the ruling), with stock of another S corporation (the acquirer) was issued to the holders of stock in the acquired S corporation, including the two trusts.
Generally new shareholders do not have to consent to the S election—rather they are normally bound by the original S election. But a QSST election is specific to the single S corporation in question, so while no gain or loss may have been triggered when the stock was issued to the two trusts, the acquiring corporation ended up with two ineligible shareholders since, without a QSST election being made timely, the trusts were ineligible shareholders. So the effect was similar to what would have happened had a C corporation been a shareholder of the acquired corporation and received stock—the S election of the acquiring corporation was terminated.
Only later was the problem noticed by the taxpayer, so the corporation had to seek a private letter ruling, both to grant relief from the inadvertent termination that took place when the trusts became shareholders and to grant the trusts the ability to file a late QSST election.
Given that the beneficiaries of the QSSTs had reported income from the S corporation as they would have had a proper election been made and the corporation been an S corporation, the IRS granted the sought for relief. So long as the beneficiaries of each trust file a QSST election within 120 days of the issuance of the letter (something presumably they managed to do), the IRS agreed to treat the termination of the S status as if it had not taken place.
The transaction in question was likely a relatively unusual one for the entities in question, and certainly having trusts with QSST in the mix is also a situation that not many advisers are going to run into. It would be fully understandable, if unfortunate, if the advisers had been so focused on the details of both negotiating the acquisition and making sure it met all of the requirements for tax free treatment that no one thought about wondering if new QSST elections had to be made.