PLR 200843027: Late ESBT election did not terminate S corporation status

Plain-English summary

A grantor trust held S corporation stock and remained an eligible shareholder for two years after its owner died. It then became ineligible because the trustee did not timely elect electing small business trust status. The corporation represented that the missed election was inadvertent, was not motivated by tax avoidance or retroactive planning, and that the parties would make required adjustments. The IRS granted § 1362(f) relief and treated the corporation as continuously maintaining S status. The trustee had 60 days from the ruling date to file an ESBT election effective from the termination date and any necessary amended returns. The IRS did not decide whether the corporation or trust otherwise met the substantive qualification rules.

Ruling snapshot

• Question: Could the corporation preserve S status after its shareholder trust failed to timely make an ESBT election?
• Outcome: Approved, provided the trustee filed the ESBT election within 60 days and made necessary return corrections.
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1

Full text (IRS public release)

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Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 200843027 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:B01
----------------------------------- PLR-124415-08
Date:
July 23, 2008

Legend:

X = --------------------------------------

A = -----------------------------

Trust = -------------------------------------------------------------

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

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

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

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

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

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

This responds to a letter dated May 12, 2008, and subsequent correspondence, written
on behalf of X, requesting relief for inadvertent termination of a subchapter S election
under § 1362(f) of the Internal Revenue Code (“Code”).

Facts:

The information submitted states that X was incorporated on Date 1 and made an S
corporation election effective Date 2. Trust, a trust that was treated (under subpart E of
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part 1 of subchapter J of chapter 1) as owned by A, was a shareholder of X. Thus,
Trust was a permitted S corporation shareholder pursuant to § 1361(c)(2)(A)(i).

On Date 3, A died. Trust continued to qualify as a permissible S corporation
shareholder under § 1361(c)(2)(A)(ii) for the two year period beginning on the date of
the deemed owner’s death and ending on Date 4. On Date 5, Trust became an
ineligible shareholder, and X’s S corporation election terminated.

X represents that effective Date 5, Trust was and is qualified to elect to be an electing
small business trust (ESBT) within the meaning of § 1361(e). X represents that there
was no intent to terminate X’s S corporation election and that the failure to timely 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 Secretary or
Commissioner may require consistent with the treatment of X as an S corporation and
the treatment of Trust as an ESBT.

Law and Analysis:

Section 1361(a)(1) 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 one class of stock.

Section 1361(c)(2)(A)(i) of the Code and § 1.1361-1(h)(1)(ii) of the Income Tax
Regulations provide 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 chapter 1) as owned by an individual who is
a citizen or resident of the United States, may be an S corporation shareholder.

Section 1361(c)(2)(A)(ii) provides that for purposes of § 1361(b)(1)(B), a trust which was
described in § 1361(c)(2)(A)(i) immediately before the death of the deemed owner and
which continues in existence after such death may be a shareholder, but only for the 2-
year period beginning on the day of the deemed owner's death.

Section 1361(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B), an ESBT may be
a shareholder.
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Section 1361(e)(1)(A) provides that for purposes of § 1361, 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 § 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) 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. 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) provides, in part, that the trustee of the trust 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)(A) provides that 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. Section 1362(d)(2)(B) provides that any termination 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 was
terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the
circumstances resulting in such termination were inadvertent, (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, and (4) the corporation for which the termination
occurred, and each person who was a shareholder in the corporation at any time during
the period specified pursuant to § 1362(f), agrees to make 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 such termination, the corporation shall be treated as an S corporation during the
period specified by the Secretary.

Conclusion:

Based solely on the information submitted and representations made, we conclude that
X’s S corporation election terminated on Date 5 because the trustee of Trust failed to
timely file and complete the required ESBT election under § 1361(e)(3). However, we
further conclude that such termination was inadvertent within the meaning of § 1362(f).
Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation on and after Date 5, unless X’s S election is otherwise terminated under
§ 1362(d), provided that the respective trustee files an ESBT election with the
appropriate service center within 60 days of the date of this letter effective Date 5 for
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Trust, and accordingly that Trust file any amended returns that are necessary to comply
with this ruling. A copy of this letter should be attached to the ESBT elections.

Except as specifically set forth above, no opinion is expressed or implied concerning the
federal tax consequences of the above-described facts under any other provision of the
Code. Specifically, we express or imply no opinion regarding whether X is otherwise
eligible to be treated as an S corporation or whether Trust is otherwise eligible to be
treated as 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 with this office, a copy of this letter is being sent
to your authorized representatives.

                                       Sincerely,

                                       Audrey W. Ellis

                                       Audrey W. Ellis
                                       Senior Counsel, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes

cc:
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