AUTOMATIC INADVERTENT TERMINATION RELIEF NOW AVAILABLE FOR S CORPS.

Rev. Proc. 94-23

SECTION 1. PURPOSE

This revenue procedure provides automatic inadvertent termination relief under section 1362(f) of the Internal Revenue Code to corporations whose S corporation status has been terminated because the stock of the corporation was transferred to a trust whose current income beneficiary (or the legal representative of the current income beneficiary) inadvertently failed to file a timely election to be a "qualified subchapter S trust" (QSST) under section 1361(d)(2).

SEC. 2. BACKGROUND

Section 1361(a)(1) defines an "S corporation" as a small business corporation for which an S election is in effect.

Section 1361(b) defines "small business corporation" as a domestic corporation that is not an ineligible corporation and that does not (A) have more than 35 shareholders, (B) have as a shareholder a person (other than an estate and other than a trust described in section 1361(c)(2)) who is not an individual, (C) have a nonresident alien as a shareholder, and (D) have more than one class of stock.

Section 1361(d)(1)(A) provides that in the case of a qualified subchapter S trust with respect to which a beneficiary makes an election under section 1361(d)(2), the trust will be treated as a trust described in section 1361(c)(2)(A)(i) (relating to trusts that may be a shareholder of a "small business corporation" under section 1361(b)(1)).

Section 1361(d)(3) sets forth the provisions a trust instrument must contain for a trust to qualify as a QSST. Under section 1361(d)(3)(A), the trust must require that: (i) during the life of the current income beneficiary, there is only one income beneficiary; (ii) any corpus distributed during the life of the current income beneficiary may be distributed only to that beneficiary; (iii) the current income beneficiary's income interest terminates on the earlier of the beneficiary's death or the trust's termination; and (iv) if the trust terminates during the current income beneficiary's life, the trust assets must be distributed to that beneficiary. In addition, section 1361(d)(3)(B) requires that the trust must distribute all of its income (within the meaning of section 643(b)) currently to one individual who is a United States resident or citizen.

Section 1361(d)(2) provides for the time and manner in which a beneficiary of a qualified subchapter S trust may elect to have the provisions of section 1361(d) apply. Included is the requirement that the QSST election be filed within 2 months and 16 days of the receipt of S corporation stock.

Section 1362(d)(2) provides that an S election terminates whenever (at any time on or after the first day of the first taxable year for which the corporation is an S corporation) the corporation ceases to be a small business corporation.

Section 1362(f) provides that if (1) an election under section 1362(a) by any corporation was terminated under section 1362(d)(2) or (3), (2) the Secretary determines that the termination was inadvertent, (3) no later than a reasonable period of time after discovery of the event resulting in the termination, steps were taken so that the corporation is once more a small business corporation, and (4) the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to section 1362(f) agree to make the adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the terminating event, the corporation will be treated as continuing to be an S corporation during the period specified by the Secretary.

Section 1.1362-4 of the Income Tax Regulations sets forth additional guidance regarding inadvertent termination relief. Section 1.1362-4(b) provides that the corporation has the burden of establishing that under the relevant facts and circumstances the Commissioner should determine that the termination was inadvertent. The fact that the terminating event was not reasonably within the control of the corporation and was not part of a plan to terminate the election, or the fact that the event took place without the knowledge of the corporation, notwithstanding its due diligence to safeguard itself against such an event, tends to establish that the termination was inadvertent. Section 1.1362-4(c) provides that inadvertent termination relief may be requested in the form of a ruling request. Section 1.1362-4(d) provides that the Commissioner may condition the granting of a ruling request on any adjustments that are appropriate. Section 1.1362-4(e) requires the corporation and all persons who were shareholders of the corporation at any time during the period specified by the Commissioner to consent to any adjustments that the Commissioner may require.

SEC. 3. SCOPE

This revenue procedure only applies to corporations that, but for a trust beneficiary's inadvertent failure to make a timely QSST election, would otherwise continue to meet the criteria for S corporation status. Section 4 of this revenue procedure contains an automatic grant of inadvertent termination relief for certain corporations that satisfy the criteria therein. This revenue procedure does not address situations in which the corporation fails to elect S corporation status because a QSST beneficiary fails to file a QSST election contemporaneously with the S election.

SEC. 4. INADVERTENT TERMINATION RELIEF

.01 PREREQUISITES FOR AUTOMATIC RELIEF.

(1) The corporation terminated its S corporation status solely because the beneficiary of a QSST (or his legal representative) failed to file a timely QSST election pursuant to section 1361(d)(2);

(2) All taxpayers whose tax liability and tax returns would be affected by the QSST election (including the beneficiary of the QSST) have reported their income (on all affected returns) consistent with the S election for the year the QSST election should have been made, as well as for any subsequent year;

(3) The failure to file a timely QSST election was inadvertent; and

(4) Within 2 years of the original due date, the beneficiary of the QSST files the election pursuant to this revenue procedure.

.02 PROCEDURAL REQUIREMENTS FOR AUTOMATIC RELIEF.

The current income beneficiary of the trust or the legal representative of the current income beneficiary (or a natural or an adoptive parent of the current income beneficiary if a legal representative has not been appointed and the current income beneficiary is a minor) must sign and file a QSST election with the service center where the corporation files its income tax return. This QSST election must state at the top of the document "FILED PURSUANT TO REV. PROC. 94-23" and include the following material:

(1) The name, address, and taxpayer identification number of the current income beneficiary, the trust, and the corporation;

(2) A statement identifying the election as an election under section 1361(d)(2);

(3) The date on which the stock of the corporation was originally transferred to the trust;

(4) Documentation to show that the trust satisfies the QSST requirements of section 1361(d)(3): for section 1361(d)(3)(A)(i) through (iv), copies of all relevant trust pages (including the first or title page); and for section 1361(d)(3)(B), either copies of the relevant trust pages or an affidavit from the trustee(s) stating that the income distribution requirements have been and will continue to be met;

(5) An affidavit from the current income beneficiary stating that the failure to file the QSST election was inadvertent and that the current income beneficiary acted diligently to correct the mistake upon its discovery;

(6) An affidavit from the corporation stating that to the best of its knowledge all taxpayers whose tax liability and tax returns would be affected by the QSST election (including the beneficiary of the QSST) have reported their income (on all affected returns) consistent with the S election for the year the QSST election should have been made and for any subsequent year;

(7) Affidavits from all shareholders during the termination period (including the beneficiary of the QSST) stating that they have reported their income (on all affected returns) consistent with the S election for the year the QSST election should have been made and for any subsequent year; and

(8) A dated declaration, signed by the current income beneficiary, which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."

.03 INADVERTENT TERMINATION RELIEF.

(1) Corporations that satisfy the requirements of sections 4.01 and .02 of this revenue procedure will automatically be granted inadvertent termination relief pursuant to the provisions of section 1362(f). Thus, the corporation will be treated as continuing to be an S corporation from the point of termination until the date the completed QSST election is filed, and thereafter, unless the S election is otherwise terminated under section 1362(d). In addition, during the termination period, the trust will be treated as a trust described in section 1361(c)(2)(A)(i), and the beneficiary of the trust will be treated, for purposes of section 678, as the owner of that portion of the trust consisting of S corporation stock.

The procedure provided herein is in lieu of the letter ruling procedure that is usually followed to obtain inadvertent termination relief under section 1362(f). Accordingly, user fees do not apply to corrective action under this revenue procedure.

(2) Corporations that do not satisfy the requirements of sections 4.01 and .02 of this revenue procedure may request inadvertent termination relief in accordance with the usual procedures under section 1362(f) and section 1.1362-4. In each of these cases, a letter ruling is required to obtain inadvertent termination relief, and the corporation must submit the appropriate user fee.

SEC. 5. EXAMPLES

.01 BENEFICIARY FAILS TO FILE. In 1992, A is the sole beneficiary of a trust that receives S corporation stock. But for the missing QSST election, the trust would have qualified as an eligible S corporation shareholder. A was unaware that a QSST election was necessary for the trust to qualify as an S corporation shareholder. Because A failed to file a proper QSST election, the corporation's S status terminated. Nevertheless, A reported A's pro rata share of S corporation income in a manner consistent with having made the QSST election. In 1993, A hires an accountant to prepare A's 1992 return. The accountant discovers that the QSST election had not been filed. A and the corporation make a timely request for relief in accordance with this revenue procedure. Consequently, the S corporation is granted inadvertent termination relief.

.02 TRUSTEE ATTEMPTS TO FILE. In 1992, B is the sole beneficiary of a trust that receives S corporation stock. The trustee of the trust signs and files a QSST election. The trustee is an unrelated third party who is not a legal representative of B. But for B's failure to sign the election, the trust would have qualified as a QSST. B did not know that the beneficiary's signature was required for a valid QSST election. Because B failed to file a proper QSST election, the corporation's S status terminated. Nevertheless, B reported B's pro rata share of S corporation income in a manner consistent with having made the QSST election. In 1993, B discovers that a proper QSST election had not been filed. B and the corporation make a timely request for relief in accordance with this revenue procedure. Consequently, the S corporation is granted inadvertent termination relief.

SEC. 6. EFFECTIVE DATE

Section 4 of this revenue procedure, concerning automatic inadvertent termination relief, is effective for all applications for relief filed within 2 years of the original due date of the QSST election, including those applications now being considered by the Service.

DRAFTING INFORMATION

The principal author of this revenue procedure is Scott N. Carlson of the Office of the Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding the applicability of this revenue procedure, contact Brad K. Saunders at (202) 622-3050 (not a toll-free call).