PLR 1317004: IRS treats an S corporation election as continuing after an inadvertent termination

Plain-English summary

The IRS ruled that an S corporation's election terminated when shares were transferred to a trust that had not made the required Electing Small Business Trust election. The IRS found that the termination was inadvertent and allowed the corporation to continue being treated as an S corporation. The relief required the trustee to file the ESBT election and amended returns, and required the corporation's shareholders to report items and distributions consistently with S corporation treatment. The required filings were due within 120 days after the ruling letter.

Ruling snapshot

• Question: Whether an S corporation could continue to be treated as an S corporation after an inadvertent termination caused by an ineligible trust shareholder.
• Outcome: Approved, subject to ESBT and amended-return conditions.
• Key authorities: IRC §§ 1361(e), 1362(f), 1366, 1367, and 1368; Treas. Reg. § 1.1361-1(m).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201317004 Third Party Communication: None
Release Date: 4/26/2013 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------ --------------------, ID No. --------------
-------------------------------------- Telephone Number:
--------------------- ----------------------
------------------------------------------ Refer Reply To:
CC:PSI:B02
PLR-132799-12
Date: November 26, 2012

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

State = --------------
D1 = --------------------
D2 = ------------------
D3 = ------------------
D4 = -----------------------
Trust = ------------------------------------------------------------------------

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

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

   This responds to a letter dated July 12, 2012 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 incorporated under the laws of State

on D1 and elected to be an S corporation effective D2. On D3, A, an individual
shareholder of X, formed Trust. On D4, A transferred shares of X to Trust. X
represents that Trust qualified to be an Electing Small Business Trust (ESBT) within the
meaning of § 1361(e). However, no election was made under § 1361(e)(3) to treat
Trust as an ESBT. Trust, consequently, was an ineligible shareholder and, as a result,
X’s S corporation election terminated on D4. 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 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as

provided in § 1361(e)(1)(B), an ESBT means any trust if (i) such trust does not have as
PLR-132799-12 2

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) no 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. 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 that the

trustee of the 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-(m)(2)(ii).

    Section 1362(f) provides, in part, 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 the termination of X’s S corporation election on D4 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 D4 and thereafter, provided X’s
S corporation election was valid and provided that the election was not otherwise
terminated under § 1361(d).

    As a condition for this ruling, the shareholders of X must include their pro-rata

share of the separately stated and nonseparately computed items of X 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. This ruling is further contingent upon (1)
the trustee of Trust filing an ESBT election effective D4 with the appropriate service
center and (2) Trust filing amended returns for taxable years beginning D4 and
thereafter consistent with the treatment of Trust as an ESBT. The ESBT election and
PLR-132799-12 3

the amended returns must be filed within 120 days following the date of this letter and a
copy of this letter should be attached to any such elections or returns. If X or its
shareholders fail to treat themselves as described above, this ruling is null and void.

   Except as specifically set forth above, no opinion is expressed concerning the

federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed on whether X was or is otherwise eligible to
be treated as an S corporation or whether Trust is eligible to be an ESBT.

    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, a copy of this letter is being sent to X’s authorized representative.

                                  Sincerely,



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

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes