PLR 1224014: IRS restores S corporation status after missed ESBT elections

Plain-English summary

The IRS ruled that a corporation's S election terminated when two trusts became shareholders without timely making the required Electing Small Business Trust elections. The IRS determined that the termination was inadvertent and allowed the corporation to continue being treated as an S corporation from the transfer date, provided the S election was otherwise valid. The trustees must file the ESBT elections within 120 days of the ruling date, with a copy of the ruling attached. The IRS did not rule on the corporation's general eligibility to be an S corporation.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment after the trusts missed their ESBT elections?
• Outcome: Approved, contingent on the trustees filing the ESBT elections within 120 days.
• Key authorities: IRC §§ 1361 and 1362

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201224014 Third Party Communication: None
Release Date: 6/15/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00 --------------, ID No. -----------------
Telephone Number:
---------------------
------------------------ Refer Reply To:
-------------------------- CC:PSI:B01
--------------------------- PLR-137337-11
--------------------------- Date:
March 07, 2012

LEGEND

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

A = --------------------------

Trust 1 = ----------------------------
--------------------------

Trust 2 = --------------------------------
--------------------------

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

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

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

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

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

This responds to a letter dated August 18, 2011, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

FACTS
PLR-137337-11 2

According to the information submitted and representations within, X was incorporated
on Date 1, under the laws of State. Effective Date 2, X elected to be treated as an S
corporation. On Date 3, A transferred shares of X to Trust 1 and Trust 2. X represents
that Trust 1 and Trust 2 have at all times met the requirements of an Electing Small
Business Trust (ESBT) except that the trustees of Trust 1 and Trust 2 did not make
timely ESBT elections under §1361(e)(3).

X represents that X and its shareholders have treated X as an S corporation at all
relevant times, and that Trust 1 and Trust 2 have been treated as ESBTs since their
dates of formation.

X represents that the failure to file ESBT elections for Trust 1 and Trust 2 was
inadvertent and was not motivated by tax avoidance or retroactive tax planning.
Further, X represents that X and its shareholders agree to make any adjustments
(consistent with the treatment of X as an S corporation) that may be required by the
Secretary.

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) defines a “small business corporation” as 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 1
class of stock.

Section 1361(c)(2)(A)(v) provides that, for purposes of § 1362(b)(1)(B), an ESBT may
be an S corporation shareholder.

Section 1361(e)(1)(A) provides that 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 such trust.

Section 1361(e)(1)(B) provides that an ESBT does 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
PLR-137337-11 3

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) 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 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(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation 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); (2)
the Secretary determines that the circumstances resulting in such ineffectiveness or
termination were inadvertent; (3) no later than a reasonable period of time after
discovery of the circumstances resulting in such ineffectiveness or 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 the 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
ineffectiveness or 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
X’s S election terminated on Date 3 because of the failure to timely file ESBT elections
for Trust 1 and Trust 2. We further conclude that the termination of X’s S election was
inadvertent within the meaning of § 1362(f). Therefore, X will be treated as an S
corporation effective Date 3 and thereafter, provided X’s S corporation election is
otherwise valid and not otherwise terminated under § 1362(d).

This ruling is contingent on the trustees of Trust 1 and Trust 2 filing with the appropriate
service center, within 120 days from the date of this letter, elections to treat Trust 1 and
Trust 2 as ESBTs effective Date 3. A copy of this letter should be attached to each
PLR-137337-11 4

ESBT election.

Except as specifically ruled upon above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation.

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3),
this ruling may not be used or cited as precedent.

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to your authorized representative.

                                  Sincerely,


                                  Joy C. Spies
                                  Joy C. Spies
                                  Acting Senior Technician Reviewer, Branch 1
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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

cc: