PLR 201239001: IRS reinstates an S corporation election after an inadvertent missed ESBT election

Plain-English summary

A company treated as an S corporation transferred its stock to a trust that otherwise qualified as an electing small business trust, but the trustee did not timely file the required ESBT election. Because the trust was not then an eligible shareholder, the company's S corporation election terminated. The IRS ruled that the termination was inadvertent and allowed the company to continue being treated as an S corporation if the trustee filed the ESBT election within 120 days. The ruling was based on the submitted facts and did not decide whether the company otherwise qualified as an S corporation or whether the trust otherwise qualified as an ESBT.

Ruling snapshot

• Question: Can the company's S corporation election be restored after an inadvertent termination caused by a missed ESBT election?
• Outcome: Approved
• Key authorities: IRC §§ 1361 and 1362; Treas. Reg. §§ 1.1361-1 and 1.1362-4

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201239001
Third Party Communication: None
Release Date: 9/28/2012
Date of Communication: Not Applicable
Person To Contact:
Index Numbers: 1362.00-00, 1362.04-00
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Telephone Number:
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---------------------------------------------- Refer Reply To:
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PLR-106419-12
Date: June 7, 2012

LEGEND

Company = -------------------------------------------------------------------------------------------------
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State = -----------

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

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

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

Trust = -------------------------------------------------------------------------------------------------
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Dear ----------------:

This letter responds to a letter dated February 2, 2012, and subsequent correspondence, submitted on behalf of Company by Company’s authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

Company incorporated in State on Date 1, and elected to be an S corporation effective Date 2. Shares of Company stock were transferred to Trust on Date 3. Company represents that Trust was eligible to be an electing small business trust (ESBT) within the meaning of § 1361(e) and has been treated as though a timely ESBT election had been made. However, the trustee of Trust made no election under § 1361(e)(3) to treat Trust as an ESBT. Therefore, Trust was not an eligible shareholder, and, as a result, Company’s S corporation election terminated on Date 3.
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Company represents that the circumstances resulting in the termination of Company’s S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. Company and its shareholders have agreed to make any adjustments consistent with the treatment of Company as an S corporation as may be required by the Secretary with respect to the period specified by § 1362(f).

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, for purposes of subchapter S, 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 the purposes of § 1362(b)(1)(B), an ESBT may be a shareholder.

Section 1361(e)(1)(A) provides that for purposes of § 1361, 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, (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)(3) provides that an election under § 1361(e) shall 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, in part, 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(d)(2) provides that an election under § 1362(a) shall be terminated whenever (at any time on or after the 1st day of the 1st taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that
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the circumstances resulting in such termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in such 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 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 termination, such corporation shall be treated as an S corporation during the period specified by the Secretary.

Section 1.1362-4(b) provides, in relevant part, that for purposes of § 1.1362-4(a), the determination of whether a termination was inadvertent is made by the Commissioner. The corporation has the burden of establishing that under the relevant facts and circumstances the Commissioner should determine that the termination was inadvertent. The fact that the terminating event was not reasonably within the control of the corporation and was not part of a plan to terminate the election, or the fact that the terminating event or circumstance took place without the knowledge of the corporation, notwithstanding its due diligence to safeguard itself against such an event or circumstance, tends to establish that the termination was inadvertent.

Section 1.1362-4(d) provides, in part, that the Commissioner may require any adjustments that are appropriate. In general, the adjustments should be consistent with the treatment of the corporation as an S corporation during the period specified by the Commissioner.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that Company’s S corporation election terminated on Date 3, when stock in Company was transferred to Trust, because the trustee of Trust failed to timely file the required ESBT election under § 1361(e)(3). We further conclude that the termination was inadvertent within the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), Company will be treated as continuing to be an S corporation on and after Date 3, provided that the trustee of Trust files an ESBT election with the appropriate service center within 120 days of this letter to be effective Date 3. A copy of this letter should be attached to the ESBT election.

Except as expressly provided herein, we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express or imply no opinion regarding whether Company is otherwise eligible to be treated as an S corporation or whether Trust is eligible to be treated as an ESBT.
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This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) 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 representative.

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,

James A. Quinn
Senior Counsel, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes