PLR 201108012: S corporation status restored after an inadvertent trust election failure

Plain-English summary

An S corporation's election terminated after stock was transferred to a trust that did not timely make the required electing small business trust election. The corporation represented that the termination was inadvertent and not motivated by tax avoidance or retroactive planning. The IRS ruled that the corporation would be treated as continuing to be an S corporation, provided the trustee filed the trust election and the trust filed consistent amended returns within 120 days. The ruling also required the corporation and shareholders to report items consistently with S corporation treatment during the affected period.

Ruling snapshot

• Question: Can the corporation retain S corporation treatment after its election terminated because the trust shareholder lacked a timely ESBT election?
• Outcome: Approved, subject to filing conditions
• 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: 201108012
Third Party Communication: None
Release Date: 2/25/2011
Date of Communication: Not Applicable
Index Number: 1361.01-02, 1362.04-00
Person To Contact:
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Refer Reply To:
CC:PSI:B03
PLR-126984-10
Date:
November 22, 2010

LEGEND

X = ---------------------------------------------------------------------------------------------
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Trust = ---------------------------------------------------------------------------------------------
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Shareholder = ---------------------------------------------------------------------------------------------
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A = ---------------------------------------------------------------------------------------------
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State = -----------

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

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

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

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

Year 1 = -------

Dear --------------:
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This responds to a letter dated June 25, 2010, and subsequent correspondence, submitted on behalf of X by its authorized representatives, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

X was incorporated on Date 1 under the laws of State and elected to be an S corporation effective Date 2. On Date 3, Shareholder transferred stock in X to Trust. X represents that Trust is eligible to be an electing small business trust (ESBT) within the meaning of § 1361(e). However, no election was made under § 1361(e)(3) to treat Trust as an ESBT. Therefore, Trust was not a permissible shareholder and, as a result, X’s S corporation election terminated on Date 3. On Date 4, X redeemed some of its stock from Trust. Trust transferred the remaining shares of X stock to A, an individual beneficiary of Trust.

X represents that the circumstances resulting in the termination of X’s S corporation election was inadvertent and was not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make any adjustments the Commissioner may require, consistent with the treatment of X as an S corporation.

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 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) provides that for purposes of § 1361(b)(1)(B), an ESBT is a permissible shareholder.

Section 1361(e)(1)(A) provides that, except as provided in § 1361(e)(1)(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 beneficiary, (ii) no interest in such trust was acquired by purchase, and (iii) an election under § 1361(e) applies to the 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.
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Section 1.1361-1(m)(2)(i) of the Income Tax Regulations 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, in relevant part, 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 termination were inadvertent; (3) no later than a reasonable period of time after discovery of the circumstances resulting in the termination, steps were taken so that the corporation is a small business corporation; 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 termination, the corporation will be treated as an S corporation during the period specified by the Secretary.

CONCLUSION

Based on the information submitted and the representations made, we conclude that X’s election to be treated as an S corporation terminated on Date 3, 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). Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation on and after Date 3, unless X’s S corporation election is otherwise terminated under § 1362(d). Accordingly, X's shareholders, in determining their respective income tax liabilities during the termination period and thereafter, 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 or loss 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 by § 1368.

This ruling is contingent upon (1) the trustee of Trust filing an ESBT election effective Date 3 with the appropriate service center and (2) Trust filing amended returns for taxable years beginning Date 3 and thereafter consistent with the treatment of the Trust as an ESBT. The ESBT election and the amended returns must be filed within 120 days following the date of this letter and a copy of this letter should be attached to
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such election and returns. If X or its shareholders fail to treat themselves as described above, this ruling is null and void.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, no opinion is expressed on whether X was or otherwise eligible to be treated as an S corporation or whether Trust is eligible to be 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 a power of attorney on file with this office, we are sending a copy of this letter to your authorized representatives.

The ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the ruling request, it is subject to verification on examination.

Sincerely,

/s/

Danielle M. Grimm
Acting Senior Technician Reviewer, Branch 3 (Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes

cc: