IRS restores S-corporation status after missed ESBT elections

Plain-English summary

The IRS restored a corporation's S-corporation status after four trusts became shareholders without timely electing to be electing small business trusts. It concluded that the corporation's S election terminated when the first trusts became ineligible shareholders, but that the termination was inadvertent under section 1362(f). The corporation would be treated as an S corporation from the termination date, and the trusts would be treated as ESBTs from their respective effective dates, if the required elections were filed within 120 days. The relief also required the corporation's shareholders to report income, basis, and distributions consistently and required a specified payment as an adjustment under section 1362(f)(4).

Ruling snapshot

• Question: Can an S corporation and four shareholder trusts receive relief after missed ESBT elections?
• Outcome: Approved, subject to the elections, reporting conditions, and required payment.
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, 1368, and 170; Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201234002 Third Party Communication: None
Release Date: 8/24/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00 ---------------------, ID No. -----------------
Telephone Number:
--------------------
------------------------------- Refer Reply To:
---------------------------- CC:PSI:B02
------------------------ PLR-100695-12
---------------------------- Date:
May 15, 2012

                                                    Legend

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

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

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

Trust 3 = --------------------------------
-----------------------

Trust 4 = ----------------------------------------------
-----------------------

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

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

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

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

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

Date 5 = ------------------------

Date 6 = -------------------

A = ----------------
PLR-100695-12 2

B = -----------------

n = -------------

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

   This responds to a letter dated December 21, 2011, and subsequent

correspondence, 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 formed in State on Date 1, and

made an election to be treated as an S corporation effective Date 2. A transferred
shares of X to Trust 1 and Trust 2 on Date 3. A transferred shares of X to Trust 3 on
Date 4. A transferred shares of X to Trust 4 on Date 5. However, B, who was the
trustee of Trust 1 and Trust 2 on Date 3, failed to make a timely and effective electing
small business trust (ESBT) election with respect to Trust 1 and Trust 2. A also failed to
make a timely and effective ESBT election with respect to Trust 3 and Trust 4.
Therefore, X's S corporation election terminated on Date 3.

   X represents that X and each of its shareholders have filed consistently with the

treatment of X as an S corporation since Date 3. X further represents that the failure to
properly file the ESBT election for 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.
PLR-100695-12 3

    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
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 election as an S corporation terminated on Date 3 and that this termination was
inadvertent within the meaning of § 1362(f). We further conclude that, pursuant to the
provisions of § 1362(f), X will be treated as being an S corporation from Date 3 and
thereafter, provided that X is otherwise eligible to be an S corporation and provided that
the election was not otherwise terminated under § 1362(d). Trust 1 and Trust 2 will be
treated as ESBTs from Date 3 and thereafter. Trust 3 will be treated as an ESBT from
Date 4 and thereafter. Trust 4 will be treated as an ESBT from Date 5 and thereafter.

     This ruling is conditioned upon the shareholders of X including in income their

pro rata share of the separately stated and nonseparately computed items of X as
provided in § 1366, making any adjustments to basis as provided in § 1367, and taking
into account any distributions made by X as provided in § 1368. If X or its shareholders
fail to treat themselves as described above, this letter ruling shall be null and void.

   This ruling is further conditioned upon B filing, with the appropriate service

center, ESBT elections effective Date 3 for Trust 1 and Trust 2, Date 4 for Trust 3, and
PLR-100695-12 4

Date 5 for Trust 4. The ESBT elections must be filed within 120 days following the date
of this letter and a copy of this letter should be attached to the election.

  As an adjustment under § 1362(f)(4), a payment of $n and a copy of this letter

must be sent to the following address: Internal Revenue Service, Cincinnati Service
Center, 201 West Rivercenter Blvd., Covington, KY 41001, Stop 31, Terri Lackey,
Manual Deposit. This payment must be sent no later than Date 6.

   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. Specifically, we express no opinion regarding X’s eligibility to be an S corporation
or the validity of its S corporation election. We express no opinion on whether Trust 1,
Trust 2, Trust 3, or Trust 4 qualify as ESBTs within the meaning of § 1361(e).

  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.

     In accordance with the power of attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

                                     Sincerely,



                                     Melissa Liquerman
                                     Branch Chief, Branch 2
                                     Office of the Associate Chief Counsel
                                     (Passthroughs & Special Industries)

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