PLR 200734012: S corporation status preserved after trust missed ESBT election

Plain-English summary

An estate transferred S corporation shares to a trust that failed to elect electing small business trust (ESBT) status on time. The IRS concluded that the missed trust election terminated the company's S corporation status, but that the termination was inadvertent. It allowed the company to be treated as continuously an S corporation from the transfer date if the trust filed its ESBT election within 60 days and the S election was otherwise valid. The IRS did not decide whether the trust actually qualified as an ESBT or whether the company otherwise met S corporation requirements.

Ruling snapshot

• Question: Could the company retain S corporation status after its shareholder trust missed the ESBT election deadline?
• Outcome: Approved, conditioned on the trust filing its ESBT election within 60 days.
• Key authorities: IRC §§ 1361(e), 1362(f); Treas. Reg. § 1.1362-4.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200734012
Third Party Communication: None
Release Date: 8/24/2007
Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.02-00,
1362.04-00, 1361.03-03
Person To Contact:
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Telephone Number:
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----------------------------------------------- Refer Reply To:
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CC:PSI:B03
PLR-132721-06
Date:
May 22, 2007

LEGEND

X = ------------------------------------------------------------------------------------------------------
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A = --------------------------

B = ----------------------------

Trust = ------------------------------------------------------------------------------------------------------
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State = ------

Date = -------------------
1

Date = ----------------------
2

Date = -----------------------
3

Date = -----------------------
4

Date = ----------------------
5
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Year = -------

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

We received the letter dated June 20, 2006, submitted on behalf of X by X’s authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code. This letter responds to that request.

FACTS

X was incorporated under the laws of State on Date 1. X elected to be treated as an S corporation effective Date 2. On Date 2, A was a shareholder of X. A and B were husband and wife, and died on Date 3 and Date 4, respectively. On Date 5, A’s estate transferred its X stock to Trust. Trust failed to make a timely election to be treated as an Electing Small Business Trust (ESBT). While preparing Year income tax returns, Trust’s accountant discovered that Trust had failed to file a timely ESBT election.

X represents that X issued Forms K-1 to Trust for the taxable years beginning Date 5, and for all subsequent years. X further represents that Trust reported and paid any tax attributable to the X stock that it held.

X represents that X and its shareholders have at all times intended X to be an S corporation since its election on Date 2, and that X and its shareholders have treated themselves consistent with S corporation status. X further represents that the failure of Trust to file a timely ESBT election was not motivated by tax avoidance or retroactive tax planning. In addition, X represents that, other than the failure to file an ESBT election for Trust, X has met the definition of an S corporation under § 1361(a)(1). X and all of its shareholders consent and agree to make any adjustments consistent with the treatment of X as an S corporation as may be required by the Secretary under
§ 1362(f).

LAW

Section 1361(a) 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 1 class of stock.
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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 this chapter) as owned by an individual who is a citizen or resident of the United States may be a shareholder of an S corporation.

Section 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an electing small business trust may be a shareholder of an S corporation. Section 1361(c)(2)(B)(v) provides that, for purposes of § 1361(b)(1), in the case of an electing small business trust, each potential current beneficiary of such trust shall be treated as a shareholder; except that, if for any period there is no potential current beneficiary of such trust, such trust shall be treated as the shareholder during such period.

Section 1361(e)(1)(A) provides that except as provided in § 1361(e)(1)(B), the term "electing small business trust" 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 paragraph (2), (3), (4), or (5) of § 170(c), or (IV) an organization described in § 170(c)(1) which holds a contingent interest in such trust and is not a potential current beneficiary, (ii) no interest in such trust was acquired by purchase, and (iii) an election under this subsection applies to such trust.

Section 1362(a)(1) provides, in general, 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(d)(2)(A) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the 1st day of the 1st taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation.

Section 1362(f) provides that if (1) an election under § 1362(a), 1361(b)(3)(B)(ii), or
§ 1361(c)(1)(A)(ii) 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 § 1362(d)(3), § 1361(b)(3)(C), or § 1361(c)(1)(D)(iii), (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 (A) so that the corporation for which the election was made or the termination occurred is a small business corporation or a qualified subchapter S subsidiary, as the case may be, or (B) 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
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period specified pursuant to this subsection, agrees to make such adjustments (consistent with the treatment of such corporation as an S corporation or a qualified subchapter S subsidiary, as the case may be) 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 or a qualified subchapter S subsidiary, as the case may be during the period specified by the Secretary.

Section 1.1362-4(b) of the Income Tax Regulations provides that, for purposes of
§ 1.1362-4(a), the determination of whether a termination was inadvertent is made by the Commissioner. 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(d) provides that the Commissioner may require any adjustments that are appropriate. In general, the adjustments required should be consistent with the treatment of the corporation as an S corporation during the period specified by the Commissioner.

CONCLUSION

Based on the facts submitted and representations made, we conclude that X’s S corporation election terminated on Date 5 when A’s estate transferred its X stock to Trust, and Trust failed to make a timely ESBT election. We also conclude that the termination was inadvertent within the meaning of § 1362(f). Consequently, we conclude that X will continue to be treated as an S corporation from Date 5 and thereafter, provided that X’s S corporation election was valid and was not, except for the event described on Date 5, otherwise terminated.

This ruling is contingent on Trust filing the appropriate ESBT election within 60 days of the date of this letter, and X’s S corporation election not being otherwise terminated under § 1362(d). A copy of this letter should be attached to the election.

Except for the specific rulings above, no opinion is expressed or implied concerning the federal tax consequences of the facts of this case under any other provision of the Code. Specifically, no opinion is expressed or implied as to whether X otherwise qualifies as a subchapter S corporation under § 1361. In addition, no opinion is expressed as to whether Trust qualifies as an ESBT under § 1361(e).
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Under a power of attorney on file with this office, we are sending a copy of this letter to your authorized representative.

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

The rulings contained in this letter are 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 request for rulings, it is subject to verification on examination.

Sincerely,

/s/

Leslie H. Finlow
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2)
A copy of this letter
A copy for § 6110 purposes