PLR 200701021: Missed trust election does not end S treatment after corrective filings

Plain-English summary

An S corporation’s election terminated when a trust bought shares without filing an electing-small-business-trust election. The IRS found the termination inadvertent under section 1362(f) and allowed continued S treatment, assuming the original election was valid and no other termination occurred. The trust would be treated as an ESBT from its share-acquisition date. Relief requires the trustee to file the ESBT election and the trust, beneficiaries, and other affected shareholders to file necessary amended returns within 60 days. Shareholders must report income, basis adjustments, and distributions consistently with the ruling or the relief becomes void. The IRS did not decide whether the trust otherwise meets ESBT eligibility rules.

Ruling snapshot

• Question: Can an omitted ESBT election be cured while preserving the corporation’s S treatment?
• Outcome: Approved, conditioned on the trust election, amended returns, and consistent shareholder reporting.
• Key authorities: IRC §§ 1361(e), 1362(f), 1366, 1367, 1368; Treas. Reg. § 1.1361-1(m)(2).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200701021
Third Party Communication: None
Release Date: 1/5/2007
Date of Communication: Not Applicable

Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
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CC:PSI:B02
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PLR-133215-06
Date:
October 02, 2006
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X = -------------------------------------------------------------------------------------------------------
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Trust = -------------------------------------------------------------------------------------------------------
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D1 = ----------------------
D2 = ----------------------

Dear ------ -----------:

This responds to a letter dated July 6, 2006, and subsequent correspondence, submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

The information submitted states that X was incorporated and made an election to be treated as an S corporation effective D1. On D2, Trust purchased shares of X stock. Trust is represented as being eligible to be an electing small business trust (ESBT) as of D2. However, the trustee of Trust failed to make an ESBT election. X’s S corporation election terminated on D2.

X represents that the failure to file the ESBT election for Trust was not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make any adjustments that the Commissioner may require, consistent with the treatment of X as an S corporation.

PLR-133215-06
2

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)(B) provides that the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which does not 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.

Section 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as provided in § 1362(e)(2)(B), 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 PCB, (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.

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 1362(d)(2) provides that (A) in general, 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 and (B) any termination under § 1362(d)(2) shall be effective on and after the date of cessation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation (A) 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 (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in the ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in the ineffectiveness or termination, steps were taken (A) so that the corporation is a small business corporation or (B) to acquire the shareholder consents; and (4) the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to § 1362(f), agrees to make such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to such period, 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.

PLR-133215-06
3

Based solely on the facts submitted and the representations made, we conclude that X’s S corporation election terminated on D2 and that the termination was inadvertent within the meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from D2 and thereafter, provided X’s S corporation election was valid and provided that the election was not otherwise terminated under § 1361(d). Trust will be treated as an ESBT from D2 and thereafter. The shareholders of X must include their pro-rata share of the separately stated and nonseparately computed items of X as provided in § 1366, make any adjustments to basis as provided in § 1367, and take into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat themselves as described above, this ruling is null and void.

This ruling is conditioned upon (1) the trustee of Trust filing an appropriately completed ESBT election effective D2; and (2) Trust, the beneficiaries of the trust, and any other affected shareholders of X filing any amended returns necessary to conform to this letter. Specifically, Trust and its beneficiaries must file amended returns consistent with the treatment of Trust as an ESBT effective D2. The ESBT elections and any amended returns must be filed within 60 days following the date of this letter and a copy of this letter should be attached to any such elections or returns.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code. In particular, we express no opinion on whether Trust is otherwise eligible to be an ESBT.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s authorized representative.

Sincerely,
Bradford R. Poston
Senior Counsel, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes