SECTION 2. BACKGROUND

.01 S Corporation Elections . (1) In General . Section 1361(a)(1) of the Internal Revenue Code (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 that year.

Section 1362(b)(1) provides that a small business corporation may make an election to be an S corporation for any taxable year (A) at any time during the preceding taxable year, or (B) at any time during the taxable year and on or before the 15th day of the 3rd month of the taxable year. Section 1.1362–6(a)(2) of the Income Tax Regulations provides that a small business corporation makes an election to be an S corporation by filing a completed Form 2553, Election by a Small Business Corporation.

Under § 1362(b)(3), if an S corporation election is made after the 15th day of the 3rd month of the taxable year and on or before the 15th day of the 3rd month of the

following taxable year, then the S corporation election is treated as made for that following taxable year.

(2) Late S Corporation Elections . Section 1362(b)(5) provides that if (A) an election under § 1362(a) is made for any taxable year (determined without regard to § 1362(b)(3)) after the date prescribed by § 1362(b) for making the election for the taxable year, or no election is made for any taxable year, and (B) the Secretary determines that there was reasonable cause for the failure to timely make the election, the Secretary may treat the election as timely made for the taxable year (and § 1362(b)(3) shall not apply).

Rev. Proc. 97–48 and Rev. Proc. 2003–43 provide simplified methods for taxpayers to request relief for a late S corporation election in certain circumstances.

.02 ESBT and QSST Elections . (1) In General . Section 1361(b)(1)(B) limits the permitted shareholders of an S corporation to domestic individuals, estates, certain trusts, and certain exempt organizations.

Section 1361(d)(1)(A) provides that a QSST is a permitted S corporation shareholder if the beneficiary of the QSST makes an election under § 1361(d)(2). A QSST is defined in § 1361(d)(3) as a trust that (1) distributes or is required to distribute all of its income to a citizen or resident of the United States, (2) has certain trust terms, including the requirement that there be only one income beneficiary, (3) does not distribute any portion of the trust corpus to anyone other than the current income beneficiary during the income beneficiary’s lifetime, including the time at which the trust terminates, and (4) the income interest of the current income beneficiary ceases on the earlier of such beneficiary’s death or the termination of the trust. Section 1361(d)(1) provides, in pertinent part, that in the case of a QSST with respect to which a beneficiary makes an election under § 1361(d)(2): (A) the trust is treated as owned by a citizen or resident of the United States, and (B) for purposes of § 678(a), the beneficiary of the trust is treated as the owner of that portion of the trust that consists of stock in an S corporation with respect to which the election under § 1361(d)(2) is made. A QSST election is made by signing and filing an election statement with the applicable Internal Revenue Service (IRS) Service

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QSub election is a regulatory election, the Commissioner may permit a late QSub election under the rules set forth in section 301.9100–3. Sections 301.9100–1 through 301.9100–3 provide the standards that the Commissioner will use to determine whether to grant an extension of time to make an election. Section 301.9100–2 provides automatic extensions of time for making certain elections. Section 301.9100–3 provides extensions of time for making elections that do not meet the requirements of § 301.9100–2.

Requests for relief under § 301.9100–3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith, and the grant of relief will not prejudice the interests of the Government. Section 301.9100–3(b)(1) provides that subject to paragraphs (b)(3)(i) through (b)(3)(iii) of § 301.9100–3, a taxpayer is deemed to have acted reasonably and in good faith if the taxpayer meets one of the requirements in § 301.9100–3(b)(1)(i)-(v). Section 301.9100–3(b)(1)(v) includes situations in which the taxpayer reasonably relied on a qualified tax professional (including a tax professional employed by the taxpayer), and the tax professional failed to make, or advise the taxpayer to make, the election.

Rev. Proc. 2003–43 provides a simplified method for taxpayers to request relief for a late QSub election if the request for relief is filed within 24 months of the due date of the election. Rev. Proc. 2004–49 provides alternative relief when the QSub election terminated as a result of a transfer (whether by sale or as part of a reorganization under § 368(a)(1)(A), (C), or (D) (but not as part of a reorganization under § 368(a)(1)(F)) by the S corporation of 100 percent of the QSub stock to another S corporation. Section 4.01 of Rev. Proc. 2004–49 allows the acquiring S corporation to request prospective relief by attaching a completed Form 8869 to its timely filed return (including extensions) for the taxable year during which the transfer occurred, and section 4.02 of Rev. Proc. 2004–49 provides alternative relief as provided by Rev. Proc. 2003–43. Section 4.03 of Rev. Proc 2004–49 also provides retroactive relief for such transactions if they occurred prior to August 16, 2004,

the corporation at any time during the period specified pursuant to § 1362(f), agrees to make any adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period. If a corporation is eligible for relief under this provision, then, notwithstanding the circumstances resulting in the ineffectiveness or termination, the corporation will be treated as an S corporation during the period specified by the Secretary.

Section 1.1362–4 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 against such an event, tends to establish that the termination was inadvertent.

Section 1.1362–4(c) provides that a corporation may request inadvertent termination relief by submitting a request for a letter ruling. 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 that the corporation and all persons who were shareholders of the corporation at any time during the time specified by the Commissioner consent to any adjustments that the Commissioner may require.

The IRS will grant relief for both the late ESBT and QSST elections and the inadvertently invalid S corporation election or inadvertent termination of the S corporation election if the standard described in § 1362(f) for an inadvertently invalid S corporation election or an inadvertent termination of an S corporation election is satisfied.

Rev. Proc. 2003–43 provides a simplified method for taxpayers to request relief for late ESBT and QSST elections if the request for relief is filed within 24 months of the due date of the election.

.03 Qualified Subchapter S Subsidiary (QSub) Elections . (1) In General . Section 1361 generally provides that an S cor

poration may elect to treat certain wholly owned subsidiaries as QSubs (as defined in § 1361(b)(3)(B)). Section 1361(b)(3)(B) defines a QSub as a domestic corporation that is not an ineligible corporation if (1) an S corporation holds 100 percent of the stock of the corporation, and (2) that S corporation elects to treat the subsidiary as a QSub. Section 1361(b)(3)(A) provides that a corporation that is a QSub is not treated as a separate corporation, and all assets, liabilities, and items of income, deduction, and credit of the QSub are treated as assets, liabilities, and items of income, deduction, and credit of the parent S corporation. Section 1.1361–3 describes the time and manner for a corporation to make a QSub election. Section 1.1361–3(a)(2) provides that an S corporation may make a QSub election by filing the election form with the applicable IRS Service Center. Form 8869, Qualified Subchapter S Sub- sidiary Election, is used to make a QSub election. Under § 1.1361–3(a)(3), the election to treat a subsidiary as a QSub may be filed at any time during the taxable year. Section 1.1361–3(a)(4) provides that the effective date is the date specified on the form (provided the date specified is not earlier than 2 months and 15 days before the date of the filing and the date specified is not more than 12 months after the date of the filing), or on the date the election form is filed if no date is specified. If an election form specifies an effective date more than 2 months and 15 days prior to the date on which the election form is filed, it will be effective 2 months and 15 days prior to the date it is filed. If an election form specifies an effective date more than 12 months after the date on which the election is filed, it will be effective 12 months after the date it is filed.

(2) Late QSub Elections . Under § 301.9100–1(c), the Commissioner may grant a reasonable extension of time under the rules set forth in §§ 301.9100–2 and 301.9100–3 to make a regulatory election, or a statutory election, under all subtitles of the Code, except subtitles E, G, H, and I.

Section 301.9100–1(b) defines the term “regulatory election” as an election whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin. Because a

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Rev. Proc. 2004–48 and Rev. Proc 2007–62 provide simplified methods for taxpayers to request relief for a late S corporation election and a late corporate classification election intended to be effective on the same date as the S corporation election.