PLR 200905019: Missed ESBT election did not end corporation's S status

Plain-English summary

A grantor trust held stock in an S corporation when its deemed owner died. The trust remained an eligible shareholder for two years after the death and then qualified as an electing small business trust, but its trustee failed to file the ESBT election. The IRS found that this omission technically terminated the corporation's S election but that the termination was inadvertent and not motivated by tax avoidance or retroactive planning. It treated the company as continuously maintaining S status and the trust as an ESBT, conditioned on the trustee filing the ESBT election within 60 days. The ruling also required the company and all shareholders to report consistently with continuous S status, including the income, basis, and distribution consequences under sections 1366 through 1368.

Ruling snapshot

• Question: Could an S corporation preserve its status after a shareholder trust failed to file an ESBT election when its post-death eligibility period ended?
• Outcome: Approved, conditioned on filing the ESBT election within 60 days and consistent reporting by the corporation and all shareholders
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 1362(d), and 1362(f); Treas. Reg. § 1.1361-1(m)(2)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200905019
Third Party Communication: None
Release Date: 1/30/2009
Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.01-03, 1362.04-00
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Telephone Number:
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------------------------------------------- Refer Reply To:
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CC:PSI:B03
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PLR-131719-08
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Date:
October 21, 2008

Company = -------------------------------------------
-----------------------------------------------------------

H = ----------------------------

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

a = -------

b = -------

c = ----------------------

d = ----------------------

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

We received a letter dated July 9, 2008, submitted on behalf of Company requesting a ruling under § 1362(f) of the Internal Revenue Code. This letter responds to that request.

FACTS

The information submitted states that Company was formed in a, under the laws of State. Company subsequently made an election to be treated as a subchapter S corporation effective in b. At the time of Company’s S corporation election, one of its

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shareholders, Trust, was a grantor trust described in § 1361(c)(2)(A)(i), the deemed owner of which was H.

On c, H died and Trust qualified under § 1361(c)(2)(A)(ii) as an eligible shareholder for two years from the date of death. Company represents that Trust qualified on d, as an electing small business trust (“ESBT”) and has been treated since then as though a timely ESBT election had been made. However, the trustee of Trust failed to properly file the ESBT election.

Company further represents that the circumstances resulting in the termination of Company’s S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. Company and its shareholders have agreed to make such adjustments, consistent with the treatment of Company as an S corporation, as may be required by the Service.

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) 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 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.

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)

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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) of the Income Tax Regulations 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 facts submitted and representations made, we conclude that Company’s election to be treated as an S corporation terminated on d, upon the failure by the trustee of Trust to properly file an ESBT election for Trust. We also conclude that the termination constituted an inadvertent termination within the meaning of § 1362(f). Accordingly, Company will be treated as continuing to be an S corporation from d, and thereafter, provided that Company’s S corporation election is not otherwise terminated under § 1362(d).

Moreover, Trust will be treated as an ESBT from d, and thereafter, provided the trustee of Trust files an ESBT election for Trust with the appropriate service center,

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effective d, within 60 days of the date of this letter. A copy of this letter should be attached to that election.

This ruling is contingent on Company and all its shareholders treating Company as having been an S corporation for the period beginning on d, and thereafter. The shareholders of Company, including Trust treated as an ESBT, must include in their income their pro rata shares of the separately stated and nonseparately computed items of Company as provided in § 1366, make any adjustments to basis as provided in
§ 1367, and take into account any distributions made by Company as provided in
§ 1368. If Company or Company’s shareholders fail to treat themselves as described above, this ruling shall be null and void.

Except as expressly provided herein, we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express or imply no opinion regarding whether Company is otherwise eligible to be treated as an S corporation or whether Trust is eligible to be treated as an ESBT.

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.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to Company’s authorized representative.

Sincerely,

/s/

Tara P. Volungis
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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