PLR 200843008: Missed trust elections did not end S corporation status

Plain-English summary

An S corporation transferred shares to seven trusts that represented they qualified as electing small business trusts, but their trustees failed to make the required ESBT elections. The trusts therefore became ineligible shareholders and terminated the corporation’s S election. The corporation represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive planning, and that it and its shareholders would make any required adjustments. The IRS ruled that the corporation would continue to be treated as an S corporation if its original election was valid and had not otherwise terminated. The relief required each trustee to file an ESBT election effective from the transfer date and each trust to file consistent amended returns within 60 days.

Ruling snapshot

• Question: Was the S corporation election’s termination caused by the trusts’ missed ESBT elections inadvertent?
• Outcome: Approved. S corporation status continued, subject to timely ESBT elections, 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: 200843008                                             Third Party Communication: None
Release Date: 10/24/2008                                       Date of Communication: Not Applicable
                                                                Person To Contact:
Index Number: 1362.04-00                                        -------------------, ID No. -------------
                                                                Telephone Number:
                                                                ---------------------
 -------------------------------------------------------        Refer Reply To:
----------------------------------------                        CC:PSI:B02
------------------------------                                  PLR-106440-08
 -----------------------------------                            Date:
                                                                July 08, 2008




 X                 =         ----------------------------------------
 --------------------------------------------------
 State             =        ------------
 D1                =        ----------------------
 D2                =        ---------------------
 Year 1            =        -------
 Trust 1           =         ---------------------------------------
 --------------------------------------------------
 Trust 2           =         --------------------------------------------
 --------------------------------------------------
 Trust 3           =         ----------------------------------------
 --------------------------------------------------
 Trust 4           =         --------------------------------------
 --------------------------------------------------
 Trust 5           =         -----------------------------------------
 --------------------------------------------------
 Trust 6           =         ------------------------------------------
 --------------------------------------------------
 Trust 7           =         -------------------------------------
 --------------------------------------------------

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

        This responds to a letter dated January 22, 2008 submitted on behalf of X by its
 authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue
 Code.

        X was incorporated under the laws of State in Year 1 and elected to be an S
 corporation effective D1. On D2, shares of X were transferred to Trust 1, Trust 2, Trust
 3, Trust 4, Trust 5, Trust 6 and Trust 7 (collectively, the “Trusts”). X represents that
 Trusts qualified to be Electing Small Business Trusts (ESBTs) within the meaning of
PLR-106440-08                                 2

§ 1361(e). However, no election was made under § 1361(e)(3) to treat Trusts as
ESBTs. Trusts, consequently, were ineligible shareholders and, as a result, X’s S
corporation election terminated on D2. X represents that the termination 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.

         Section 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as
provided in § 1361(e)(1)(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 potential current beneficiary,
(ii) no interest in such trust was acquired by purchase, and (iii) no 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. Any such election shall apply to the taxable year
of the trust for which made and all subsequent taxable years of such trust unless
revoked with the consent of the Secretary.

       Section 1.1361-1(m)(2)(i) of the Income Tax Regulations provides that the
trustee of the 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-(m)(2)(ii).

        Section 1362(f) provides, in part, 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.

        Based solely on the facts submitted and the representations made, we conclude
that the termination of X’s S corporation election on D2 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
PLR-106440-08                                3

S corporation election was valid and provided that the election was not otherwise
terminated under § 1361(d).

        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. This ruling is further contingent upon (1) the respective trustees of
each of the Trusts filing an ESBT election effective D2 with the appropriate service
center and (2) each of the Trusts filing amended returns for taxable years beginning D2
and thereafter consistent with the treatment of the Trusts as ESBTs. The ESBT
elections and the 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. If X
or its shareholders fail to treat themselves as described above, this ruling is null and
void.

       Except as specifically set forth above, no opinion is expressed concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed on whether X was or is otherwise eligible to
be treated as an S corporation or whether Trusts are eligible to be ESBTs.

        This ruling is directed only to the taxpayer that requested it. Section 6110(j)(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,



                                      Melissa C. Liquerman
                                      Senior Technician Reviewer, Branch 2
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)

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




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