PLR 1228024: IRS restores S corporation status after an inadvertent termination

Plain-English summary

An S corporation's election terminated when a trust that held its stock failed to make an electing small business trust election. The stock then passed to another trust before being transferred to two eligible shareholders. The IRS concluded that the termination was inadvertent and allowed the corporation to be treated as continuing to be an S corporation from the termination date, assuming its election was otherwise valid. It also treated each trust as an electing small business trust for the period when it held the stock, subject to filing returns consistent with that treatment. The corporation and its shareholders had to follow the required S corporation reporting, basis, and distribution rules, or the ruling would be null and void.

Ruling snapshot

• Question: Could the corporation continue to be treated as an S corporation after its election terminated because a trust shareholder failed to make an ESBT election?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362(f), 1366, 1367, and 1368

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201228024 Third Party Communication: None
Release Date: 7/13/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00 ----------------------, ID No. -------------
Telephone Number:
--------------------
------------------------ Refer Reply To:
----------------- CC:PSI:B03
-------------------------------- PLR-144665-11
------------------------ Date:
February 07, 2012

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

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

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

D1 = -------------------

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

    This responds to a letter dated October 14, 2011, and subsequent

correspondence, submitted on behalf of X by its authorized representatives requesting a
ruling under § 1362(f) of the Internal Revenue Code.

    X made an election to be treated as an S corporation. X’s election was

inadvertently terminated effective D1, when Trust 1 ceased to qualify as an eligible
shareholder by failing to make an electing small business trust (“ESBT”) election. Trust
1 transferred its X stock to Trust 2, which held the X stock until it transferred the stock to
two eligible shareholders. X represents that the termination 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 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
PLR-144665-11 2

§ 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
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 the termination of X’s S corporation election on D1 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 D1 and thereafter, provided X’s
S corporation election was valid and provided that the election was not otherwise
terminated under § 1361(d). Moreover, each of Trust 1 and Trust 2 will be treated as an
ESBT during the period for which it held X stock, provided each trust files income tax
returns for such period consistent with an ESBT election having been made.

   This ruling is conditioned upon X and all its shareholders treating X as having

been an S corporation for the termination period and thereafter. Moreover, the
shareholders of X must include their pro rata share of the separately stated and
nonseparately computed items of income, loss, deduction, or credit 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.
PLR-144665-11 3

    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. 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. Pursuant to a power of attorney
on file, we are sending a copy of this letter to X’s authorized representatives.

                                 Sincerely,

                                 /s/

                                 Richard T. Probst
                                 Senior Technician Reviewer, Branch 3
                                 Office of the Associate Chief Counsel
                                 (Passthroughs & Special Industries)

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

cc: