PLR 1233001: IRS preserves S corporation status after inadvertent ESBT election failure

Plain-English summary

An S corporation had two trusts as shareholders, but the trustees did not timely file the electing small business trust elections needed for the trusts to be permissible shareholders. The IRS therefore found that the corporation's S election was initially ineffective, but also found that the failure was inadvertent. The IRS allowed the corporation to be treated as an S corporation from the intended effective date if both trustees filed the required ESBT elections within 120 days and the other eligibility conditions were satisfied. The ruling did not decide whether the corporation or trusts otherwise qualified.

Ruling snapshot

• Question: Could the corporation retain S corporation treatment after its shareholder trusts failed to timely file ESBT elections?
• Outcome: Approved, subject to filing the ESBT elections within 120 days and other conditions.
• Key authorities: IRC §§ 1361(a), (b)(1)(B), (c)(2)(A)(v), (e), and 1362(a), (d), and (f); Treas. Reg. § 1.1361-1(m)(2).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201233001 Third Party Communication: None
Release Date: 8/17/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.01-00, 1362.01-03 --------------------, ID No. -----------------
Telephone Number:
------------------------------------------------- ---------------------
--------------------------------------------------- Refer Reply To:
------------------------------------------------------ CC:PSI:B01
-------------------------- PLR-100944-12
Date:
May 18, 2012

Legend

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

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

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

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

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

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

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

    This responds to a letter dated December 27, 2011, and subsequent

correspondence, submitted on behalf of X from X’s authorized representative,
requesting inadvertent invalid S corporation election relief pursuant to § 1362(f) of the
Internal Revenue Code.

FACTS

   The information submitted states that X was incorporated under the laws of State

on Date 1. X represents that it timely filed an election to be treated as an S corporation
which was intended to be effective on Date 2.
PLR-100944-12 2

    On Date 2, the shareholders of X included Trust 1 and Trust 2 (together, the

Trusts). The trustees of Trust 1 and Trust 2 intended to file an electing small business
trust (ESBT) election for Trust 1 and Trust 2 effective Date 2. X represents that each of
Trust 1 and Trust 2 was eligible to be an electing small business trust effective Date 2
and thereafter. However, no elections to be electing small business trusts were filed on
behalf of Trust 1 and Trust 2. Therefore, the Trusts were not permissible shareholders,
and X’s S corporation election was ineffective.

   X represents that Trust 1 and Trust 2 reported their allocable shares of the

Trusts' income on all affected returns consistent with the treatment of the Trusts as
ESBTs. X further represents that X filed as an S corporation for all years from and after
Date 2. X represents that the circumstances resulting in the termination of X's S
corporation election were inadvertent and were not motivated by tax avoidance or
retroactive tax planning. X and its shareholders have agreed to make such adjustments
(consistent with the treatment of X as an S corporation) as may be required by the
Secretary.

LAW AND ANALYSIS

  Section 1362(a) provides that, except as provided in § 1362(g), a small business

corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

    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, in part, 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(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B), an

electing small business trust may be a shareholder.

   Section 1361(e)(1)(A) provides that, except as provided in § 1361(e)(1)(B), the

term “electing small business trust” means any trust if (i) such trust does not have as a
beneficiary any person other than (I) an individual, (II) an estate, or (III) an organization
described in paragraph (2), (3), (4), or (5) of § 170(c), 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.
PLR-100944-12 3

   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 the trust 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(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 paragraph (2)
or (3) of § 1362(d); (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 (A) so that the corporation for which the election was
made or the termination occurred is a small business corporation, or (B) to acquire the
required shareholder consents; and (4) the corporation for which the election was made
or 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 ineffectiveness or termination, such
corporation shall be treated as an S corporation during the period specified by the
Secretary.

CONCLUSION

    Based solely on the representations made and the information submitted, we

conclude that X's S corporation election was ineffective on Date 2 because X had
ineligible shareholders. We also conclude that the election was inadvertently invalid
under § 1362(f). Therefore, pursuant to the provisions of § 1362(f), X will be treated as
an S corporation from Date 2 and thereafter, provided that the trustee of each of Trust 1
and Trust 2 files an ESBT election, pursuant to the procedures set forth in § 1.1361-
1(m)(2) effective Date 2, with the appropriate service center within 120 days of the date
of this letter, and provided that X's election to be an S corporation was not otherwise
invalid and was not terminated under § 1362(d). A copy of this letter should be attached
to the ESBT elections.

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of any aspect of the transactions described above under
any other provision of the Code. Specifically, we express no opinion concerning
PLR-100944-12 4

whether X was or is otherwise eligible to be an S corporation or whether the Trusts were
or are otherwise eligible to be ESBTs.

   This ruling letter 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, a copy of this letter

is being sent to X's authorized representative.

                                   Sincerely,



                                   David R. Haglund
                                   David R. Haglund
                                   Chief, Branch 1
                                   Office of the Associate Chief Counsel
                                   (Passthroughs & Special Industries)

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