PLR 201015001: IRS preserves S corporation status after late ESBT elections

Plain-English summary

The IRS ruled that a corporation's S corporation election was inadvertently terminated when two trusts became ineligible shareholders after failing to make timely Electing Small Business Trust elections. The corporation and its shareholders agreed to treat the corporation as an S corporation and make any required adjustments. The IRS granted relief under section 1362(f), conditioned on the trusts making valid ESBT elections effective on the termination date within 60 days and amending relevant returns. The ruling did not address the corporation's or trusts' underlying eligibility beyond those conditions.

Ruling snapshot

• Question: Could the corporation's S corporation status continue after an inadvertent termination caused by untimely ESBT elections?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, and 6110(k)(3); Treas. Reg. § 1.1361-1(m)(2)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201015001
Third Party Communication: None
Release Date: 4/16/2010
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
----------------------------------------------- --------------------, ID No. -------------
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Telephone Number:
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Refer Reply To:
CC:PSI:B01
PLR-107792-09
Date:
August 12, 2009

Legend

X = ---------------------------------------------------
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A = ------------------------

State = ----------

Trust 1 = ----------------------------------------------------------------------------
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Trust 2 = -----------------------------------------------------------------------------------------
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Date 1 = ----------------------

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

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

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

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

Dear --------------:
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This responds to a letter dated February 18, 2009, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code.

Facts

The information submitted states that X is a State corporation that elected to be an S corporation effective Date 1.

In Date 2, Trust 1 acquired shares of X stock. In Date 2, Trust 2 was formed and, in Date 3, Trust 2 acquired shares of X stock. A, the president of X, represents that Trust 1 and Trust 2 were treated as grantor trusts that were eligible shareholders of X until Date 4. X represents that, as of Date 4, Trust 1 and Trust 2 were no longer eligible to be treated as grantor trusts but were eligible to elect to be treated as electing small business trusts (ESBTs). However, the trustees of each such trust failed to make an ESBT election in a timely manner.

X represents that the failure to file the ESBT elections for Trust 1 and Trust 2 was inadvertent and was not motivated by tax avoidance or retroactive tax planning. X represents that all of the taxable income attributable to the shares in X held by Trust 2 has been reported consistently with the trust being an ESBT effective Date 5. X and its shareholders have agreed to make any adjustments (consistent with the treatment of X as an S corporation) as may be required by the Secretary with respect to the period specified by § 1362(f).

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)(B) provides that, for purposes of subchapter S, 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(c)(2)(A)(v) provides that, for the purposes of § 1362(b)(1)(B), an ESBT may be an S corporation shareholder.

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 potential current
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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)(1)(B) provides that the term “electing small business trust” shall not include (i) any qualified subchapter S trust (as defined in § 1361(d)(3)) if an election under § 1361(d)(2) applies to any corporation the stock of which is held by such trust, (ii) any trust exempt from tax under subtitle A, and (iii) any charitable remainder annuity trust or charitable remainder unitrust (as defined in § 664(d)).

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 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 1.1361-1(m)(2)(iii) provides that the trustee of an ESBT must file the ESBT election within the time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a QSST election (generally within the 16-day-and-2-month period beginning on the day that the stock is transferred to the trust).

Section 1362(d)(2) 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. The termination is effective on and after the day of the termination.

Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2); (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 such corporation at any time during the period specified pursuant to § 1362(f), agrees to make such adjustments (consistent with the treatment of such 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
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Based solely on the information submitted and the representations made, we conclude that X's S corporation election was terminated on Date 4, when Trust 1 and Trust 2 became ineligible shareholders. We further conclude that the termination of X’s S corporation election was an inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date 4 and thereafter, provided that, apart from the inadvertent termination ruling and the rulings for relief from the late ESBT elections herein, X's S corporation election was otherwise valid and has not otherwise terminated under § 1362(d).

This ruling is contingent on X and all of its shareholders treating X as having been an S corporation for the period beginning Date 4 and thereafter. Accordingly, in determining their respective income tax, all the shareholders of X must include their pro- rata share of the separately stated items of income (including tax-exempt income), loss, deduction, or credit and nonseparately computed items of income and loss of X as provided in § 1366, make adjustments to basis as provided in § 1367, and take into account any distributions made by X as provided in § 1368. If X or its shareholders fail to treat themselves as described above, this ruling is null and void.

This ruling is also contingent on Trust 1 and Trust 2 each making a valid ESBT election effective Date 4 with the appropriate service center within 60 days of this letter. Provided that this election is made, from Date 4 and thereafter, Trust 1 and Trust 2 will each be treated as an ESBT under § 1361(e). This ruling is also contingent on Trust 1 and Trust 2 each amending its returns for all relevant years consistent with the trust being an ESBT effective as of Date 4.

Except as specifically ruled above, we express or imply no opinion concerning the federal tax consequences of the transactions described above under any other provision of the Code. Specifically, we express or imply no opinion regarding whether X is otherwise eligible to be an S corporation, whether Trust 1 or Trust 2 otherwise qualifies as a valid ESBT, and whether Trust 1 and Trust 2 were eligible S corporation shareholders prior to Date 4.

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

Sincerely,

Faith P. Colson
Senior Counsel, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)
Enclosures (2)
Copy of this letter
Copy for §6110 purposes