PLR 1244002: IRS grants relief for an inadvertent S-corporation termination

Plain-English summary

An S corporation transferred shares to three trusts, but the trustees did not timely make the required elections to treat the trusts as electing small business trusts. The corporation represented that the trusts met the ESBT requirements, that the termination was inadvertent, and that the corporation and its shareholders would make any required adjustments. The IRS ruled that the S election had inadvertently terminated on the first transfer date and would have terminated again on a later transfer date, but allowed the corporation to continue being treated as an S corporation under IRC § 1362(f). The relief requires the three ESBT elections to be filed with the appropriate service center within 120 days of the ruling.

Ruling snapshot

• Question: May the corporation retain its S-corporation status after late ESBT elections caused an inadvertent termination?
• Outcome: Approved
• Key authorities: IRC §§ 1361 and 1362; Treas. Reg. § 1.1361-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201244002 Third Party Communication: None
Release Date: 11/2/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 1362.04-00, 1362.02-03 --------------, ID No. -----------------
Telephone Number:
---------------------------------------- --------------------
------------------------------- Refer Reply To:
---------------------------- CC:PSI:B01
---------------------------- PLR-104479-12
Date:
July 09, 2012

LEGEND

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

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

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

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

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

Year = -------

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

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

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

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

Dear ----------------.:

PLR-104479-12 2

This responds to a letter dated January 31, 2012, submitted on behalf of X by X’s
authorized representative, requesting relief under section 1362(f) of the Internal
Revenue Code (the Code).

FACTS

According to the information submitted and representations within, X was incorporated
in Year, under the laws of State. Effective Date 1, X elected to be taxed as an S
corporation. A was a shareholder of X. On Date 2, A transferred X shares to Trust 1
and Trust 2. On Date 3, A transferred X shares to Trust 3. Timely elections to treat
Trust 1, Trust 2, and Trust 3 as ESBTs were not made.

X represents that Trust 1, Trust 2 and Trust 3 have at all times met the requirements of
an ESBT within the meaning of § 1361(d)(3). Throughout the period that Trust 1,
Trust 2, and Trust 3 have been shareholders of X, they have each filed their federal
income tax returns consistent with being an ESBT. X represents that its S corporation
election termination 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 required as a condition of obtaining relief under the inadvertent
termination rule as provided under § 1362(f) of the Code that may be required by the
Secretary.

LAW AND ANALYSIS

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) 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 electing
small business trust (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.

PLR-104479-12 3

Section 1361(e)(1)(B) provides that the term “electing small business trust” shall 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 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) 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 inadvertently terminated within the meaning of § 1362(f) on Date 2 when
A transferred X shares to Trust 1 and Trust 2, We further conclude, had X’s S election
not already terminated, it would have inadvertently terminated on Date 3 when A
transferred X shares to Trust 3. Pursuant to the provisions of § 1362(f), X will be
treated as an S corporation from Date 2 and thereafter, provided X’s S corporation

PLR-104479-12 4

election is not otherwise terminated under § 1362(d).

Within 120 days from the date of this letter, an election to treat Trust 1 and Trust 2 each
as an ESBT effective Date 2 and an election to treat Trust 3 as an ESBT effective Date
3, must be made with the appropriate service center. A copy of this letter should be
attached to the 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,


                                  Faith Colson
                                  Faith Colson
                                  Senior Counsel, 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: