PLR 200845036: Late ESBT election did not end S corporation status

Plain-English summary

An S corporation transferred shares to a trust that was represented as eligible to be an electing small business trust, but the trustee did not timely make the ESBT election. That omission technically terminated the corporation’s S election. The company represented that the mistake was not tax-motivated, that all affected returns consistently treated it as an S corporation, and that the parties would make required adjustments. The IRS ruled that the termination was inadvertent and treated both S status and the ESBT election as continuous from the transfer date. The trustee had to file the ESBT election within 60 days and attach the ruling.

Ruling snapshot

• Question: Could the company retain S status despite the trust’s late ESBT election?
• Outcome: Approved. S status continued, and the ESBT election was treated as timely if filed within 60 days.
• Key authorities: IRC §§ 1361(e) and 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200845036
Third Party Communication: None
Release Date: 11/7/2008
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00, 1361.03-03
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Telephone Number:
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Refer Reply To:
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CC:PSI:B1
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PLR-124807-08
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Date:
July 31, 2008

Legend:

X = ---------------------------
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Trust = ------------------------------------------

Year 1 = -------

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

State = ------

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

This letter responds to your letter dated February 2, 2008, requesting relief under
§ 1362(f) of the Internal Revenue Code.

Facts:

You have represented that the facts are as follows. X is a corporation organized under the laws of State. During Year 1, X filed Form 2553, electing to be taxed as an S corporation. On Date 1, some shares of X stock were transferred to Trust. Trust is represented as being eligible to be an electing small business trust (ESBT) as of Date 1. However, the trustee of Trust failed to make a timely ESBT election. Therefore, X’s S corporation election terminated on Date 1.
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X represents that the failure to file the ESBT election for Trust was not motivated by tax avoidance or retroactive tax planning. X represents that X and all of its shareholders have filed returns consistent with X’s status as an S corporation since Date 1. X and its shareholders have also agreed to make any adjustments that the Commissioner may require, consistent with the treatment of X as an S corporation.

Law and Analysis:

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
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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.

Conclusion:

Based solely on the facts submitted and the representations made, we conclude that X's election to be treated as an S corporation terminated on Date 1. We also conclude that the termination constituted an "inadvertent termination" within the meaning of § 1362(f). Under the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 1 and thereafter, and the trustee of Trust will be treated as having filed timely an ESBT election for Trust, effective Date 1, provided that X's S corporation election is not otherwise terminated under § 1362(d) and provided further that the trustee of Trust files an ESBT election for Trust with the appropriate service center, effective Date 1, within 60 days of the date of this letter. A copy of this letter should be attached to the election.

Except as specifically provided herein, no opinion is expressed or implied as to the federal tax consequences of the facts described above under any other provision of the Code. In particular, no opinion is expressed as to whether X is otherwise eligible to be an S corporation or whether Trust is an eligible ESBT under § 1361(e).

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.
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Pursuant to a power of attorney on file with this office, a copy of this letter is being sent to X's authorized representatives.

Sincerely,

David R. Haglund

David R. Haglund
Senior Technician Reviewer, Branch 1
Office of Associate Chief Counsel
Passthroughs & Special Industries

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

cc: