PLR 1042002: IRS grants relief for missed ESBT elections

Plain-English summary

The IRS considered an S corporation whose shareholders transferred shares to fourteen trusts but whose trustees failed to make the required electing small business trust, or ESBT, elections. The corporation and shareholders had consistently treated the trusts as ESBTs, and the IRS found that the resulting S-election termination was inadvertent. It treated the corporation as continuing to be an S corporation and treated each trust as an ESBT from the applicable transfer date, subject to the ruling's conditions. The trustees had to file the ESBT elections, and the trusts, beneficiaries, and other affected shareholders had to file necessary amended returns within 120 days. The ruling became null and void if the parties failed to follow the required treatment.

Ruling snapshot

• Question: Can an S corporation and its trust shareholders receive relief after the trustees failed to make ESBT elections?
• Outcome: Approved
• Key authorities: IRC §§ 1361(a)(1), 1361(b)(1)(B), 1361(e), 1362(d)(2), 1362(f), 1366, 1367, 1368, 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: 201042002 Third Party Communication: None
Release Date: 10/22/2010 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------------ --------------------, ID No. -------------
---------------------------------------------- Telephone Number:
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------------------------------------ Refer Reply To:
CC:PSI:B02
PLR-102470-10
Date:
June 28, 2010

X = -----------------------------------------------------------------------------------------------------
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State = -------------

Trust 1 = -----------------------------------------------------------------------------------------------------
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Trust 2 -----------------------------------------------------------------------------------------------------
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Trust 3 -----------------------------------------------------------------------------------------------------
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Trust 4 -----------------------------------------------------------------------------------------------------
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Trust 5 -----------------------------------------------------------------------------------------------------
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Trust 6 -----------------------------------------------------------------------------------------------------
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Trust 7 -----------------------------------------------------------------------------------------------------
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Trust 8 -----------------------------------------------------------------------------------------------------
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Trust 9 -----------------------------------------------------------------------------------------------------
PLR-102470-10 2

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Trust 10 -----------------------------------------------------------------------------------------------------
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Trust 11 -----------------------------------------------------------------------------------------------------
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Trust 12 -----------------------------------------------------------------------------------------------------
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Trust 13 -----------------------------------------------------------------------------------------------------
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Trust 14 -----------------------------------------------------------------------------------------------------
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D1 = ----------------------
D2 = ----------------------
D3 = --------------------------
D4 = -------------------
D5 = ---------------------------
D6 = -------------------

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

     This responds to a letter dated January 15, 2010, submitted on behalf of X by its

authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue
Code.

      The information submitted states that X was incorporated in State on D1 and

made an election to be treated as an S corporation effective D2. On D3, a shareholder
of X transferred shares of X stock to Trust 1, Trust 2, Trust 3, and Trust 4. Trust 1,
Trust 2, Trust 3, and Trust 4 are represented as being eligible to be electing small
business trusts (ESBT) as of D3. However, the trustees of the trusts failed to make
ESBT elections for each trust. X’s S corporation election terminated on D3.

     Additionally, shareholders of X transferred shares of X stock to Trust 5, Trust 6,

Trust 7, Trust 8, and Trust 9 on D4, to Trust 10, Trust 11, and Trust 12 on D5, and to
Trust 13 and Trust 14 on D6. Each trust is represented as being eligible to be an ESBT
as of D4, D5, and D6, respectively.

     X and its shareholders have consistently treated each trust as an ESBT from the

date the shareholders transferred shares of X stock to the trusts.
PLR-102470-10 3

   X represents that the failure to file the ESBT elections for each trust was not

motivated by tax avoidance or retroactive tax planning. X and its shareholders have
agreed to make any adjustments that the Commissioner may require, consistent with
the treatment of X as an S corporation.

   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 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
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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.

    Based solely on the facts submitted and the representations made, we conclude

that X’s S corporation election terminated on D3 and that the termination was
inadvertent within the meaning of § 1362(f). We further hold that, pursuant to the
provisions of § 1362(f), X will be treated as continuing to be an S corporation from D3
and thereafter, provided X’s S corporation election was valid and provided that the
election was not otherwise terminated under § 1361(d). Trust 1, Trust 2, Trust 3, and
Trust 4 will be treated as ESBTs from D3 and thereafter. Trust 5, Trust 6, Trust 7, Trust
8, and Trust 9 will be treated as ESBTs from D4 and thereafter. Trust 10, Trust 11, and
Trust 12 will be treated as ESBTs from D5 and thereafter. Trust 13 and Trust 14 will be
treated as ESBTs from D6 and thereafter. The shareholders of X must include their
pro-rata share of the separately stated and nonseparately computed items of X as
provided in § 1366, make any 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 conditioned upon (1) the trustees of the trusts filing appropriately

completed ESBT elections effective D3, D4, D5, and D6; and (2) the trusts, the
beneficiaries of the trusts, and any other affected shareholders of X filing any amended
returns necessary to conform to this letter with the appropriate service center within 120
days following the date of this letter. A copy of this letter should be attached to each
ESBT election.

   Except as specifically ruled above, we express no opinion concerning the federal

tax consequences of the transactions described above under any other provisions of the
Code. In particular, we express no opinion on whether the trusts are otherwise eligible
to be ESBTs.

  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.
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   Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s

authorized representatives.

                                   Sincerely,



                                   Charlotte Chyr
                                   Senior Technician Reviewer, Branch 2
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes