IRS treats an S corporation election as continuing after an inadvertent termination

Plain-English summary

An S corporation's stock was transferred to a trust that did not timely file an Electing Small Business Trust election, which caused the corporation's S corporation status to terminate. The corporation represented that the trust met the ESBT requirements, that the termination was not intended or tax-motivated, and that the corporation and shareholders would make required adjustments. The IRS determined that the termination was inadvertent and ruled that the corporation would continue to be treated as an S corporation from the stock-transfer date onward, assuming its election was otherwise valid. The ruling required the trust beneficiary to file the ESBT election within 60 days and made the ruling void if the stated conditions were not met.

Ruling snapshot

• Question: May the corporation continue its S corporation status after the trust's late ESBT election caused an inadvertent termination?
• Outcome: Approved
• Key authorities: IRC §§ 1361 and 1362(f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201003002
Third Party Communication: None
Release Date: 1/22/2010
Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.03-02
Person To Contact:
-----------------
---------------, ID No. -------------
---------------------------------------
Telephone Number:
---------------------------
---------------------
--------------------------
Refer Reply To:
-------------------------------------------- CC:PSI:B01 PLR-121442-09
Date: October 20, 2009

Legend:

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

State = ------

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

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

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

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

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

This responds to a letter dated April 15, 2009, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS
PLR-121442-09
2

According to the information submitted, X was incorporated on Date 1 under the laws of State. X elected to be treated as an S corporation effective Date 2. On Date 3, stock in X was transferred to Trust . Trust did not file a timely Electing Small Business Trust (ESBT) election resulting in the termination of X’s S corporation status.

X represents that Trust has, at all times since the transfer of X stock to Trust, met the requirements of an electing small business trust (ESBT), within the meaning of § 1361(e)(1) and that Trust has filed its tax returns consistent with being an ESBT. X represents that it did not intend for its S corporation election to terminate and the termination was not motivated by tax avoidance. Finally, X and its shareholders agree to make any adjustments required by the Secretary consistent with the treatment of X as an S corporation.

LAW AND ANALYSIS

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which an election under § 1362(a) is in effect for the taxable year.

Section 1361(b)(1)(B) provides that a small business corporation cannot 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(c)(2)(A)(v) states that an electing small business trust (ESBT) is a permissible shareholder of an S Corporation.

Section 1361(e)(1) defines an ESBT, in part, as a trust if such trust does not have (1) a beneficiary any person other than (I) an individual, (II) an estate, (III) an organization described in paragraph (2), (3), (4), or (5) of section 170(c), or (IV) an organization described in section 170(c)(1) which holds a contingent interest in such trust and is not a potential current beneficiary; (2) no interest in such trust was acquired by purchase, and; (3) an election under this subsection applies to such trust.

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 taxable year for which the corporation is an S corporation) the corporation ceases to be a small business corporation. The termination is effective on and after the day of cessation.
§ 1362(d)(2)(B).

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 consent, or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of
PLR-121442-09
3

time after discovery of the circumstances resulting in the termination, steps were taken - (A) so that the corporation is a small business corporation, or (B) to acquire the required 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 this subsection, 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 such termination, such corporation shall 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 the termination of X=s S election constituted an Ainadvertent termination@ within the meaning of ' 1362(f).

Further, we conclude that, pursuant to ' 1362(f), X will be treated as continuing to be an S corporation from Date 3 and thereafter, assuming X=s S election is valid and not otherwise terminated under ' 1362(d).

This ruling is contingent upon X and all its shareholders treating X as having been an S corporation and Trust as an ESBT for the period beginning Date 3, and thereafter. Within 60 days from the date of this letter, the beneficiary of Trust must elect to treat Trust as an ESBT, effective Date 3, with the appropriate service center. A copy of this letter should be attached to the election. If these conditions are not met, then this ruling is null and void.

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, including whether X was otherwise a valid S corporation, or whether Trust was otherwise a valid ESBT.

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.

Sincerely,

Faith Colson

Faith Colson
Senior Counsel, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)