PLR 1320006: IRS restores S corporation treatment after a missed ESBT election

Plain-English summary

The IRS considered a corporation whose S corporation election terminated after stock was transferred to a trust that did not timely file an election to be treated as an electing small business trust. The IRS found that the missed election was inadvertent and allowed the corporation to continue being treated as an S corporation, subject to the ruling's conditions. The trustee had to file the ESBT election retroactively, and the corporation, trust, and shareholders had to file amended returns and make related tax adjustments. The ruling also required a specified payment by a stated deadline.

Ruling snapshot

• Question: May the corporation continue to be treated as an S corporation after a trust shareholder missed its ESBT election?
• Outcome: Approved
• Key authorities: IRC §§ 1361, 1362, 1366, 1367, and 1368; Treas. Reg. § 1.1362-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201320006 Third Party Communication: None
Release Date: 5/17/2013 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------------ -----------------------, ID No. -------------------
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------------------------------ Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-132856-12
Date:
January 14, 2013

                                              LEGEND

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

Trust = --------------------------------------------------------------------------------------------------
------------------------------------------------------------------

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

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

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

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

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

Year = -------

$n = ----------

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

   This letter responds to a letter dated July 23, 2012, and subsequent

correspondence, written on behalf of X, requesting a ruling under § 1362(f) of the
Internal Revenue Code.
PLR-132856-12 2

                                      Facts

    X was incorporated under the laws of State on Date 1. X elected to be an S

corporation effective Date 2. On Date 3, shares of X’s stock were transferred to Trust.
X represents that Trust was 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. Consequently, Trust was an ineligible shareholder, and, as a
result, X’s S corporation election terminated on Date 3.

   X represents that there was no intent to terminate X’s S corporation election and

that the failure to timely file the ESBT election for Trust was inadvertent and not
motivated by tax avoidance or retroactive tax planning. For all taxable years, X and X’s
shareholders income was reported consistent with X qualifying as an S corporation. In
addition, X and X’s shareholders agree to make any adjustments consistent with the
treatment of X 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) defines a “small business corporation” as a domestic

corporation which is not an ineligible shareholder 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 § 1361(b)(1)(B), an ESBT

is a permissible 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, (III) an organization
described in § 170(c)(2)-(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 be made by

the trustee. Any such election shall apply to the taxable year of the trust for which made
and subsequent taxable years of such trust unless revoked with the consent of the
Secretary.
PLR-132856-12 3

   Section 1362(d)(2)(A) 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, in relevant part, that if (1) an election under § 1362(a)

by any corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary
determines that 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 of the corporation at any
time during the period specified pursuant to § 1362(f), agrees to make the adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to this period, then, notwithstanding the
circumstances resulting in the termination, the corporation shall be treated as an S
corporation during the period specified by the Secretary.

  Section 1.1362-4(d) of the Income Tax Regulations provides that the

Commissioner may require any adjustments that are appropriate. In general, the
adjustments required 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

X’s S corporation election was terminated on Date 3 when stock in X was transferred to
Trust because Trust failed to timely file an 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), X will be treated as continuing to be an S
corporation on and after Date 3, unless X’s S corporation election is otherwise
terminated under § 1362(d). The trustee of Trust must file an ESBT election effective
Date 3 with the appropriate service center within 120 days of the date of this letter. A
copy of this letter should be attached to the ESBT election.

   Accordingly, the shareholders of X must include in their income their pro rata

share of separately stated and nonseparately computed items of X as provided in
§ 1366 and 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 contingent upon X and
each of its shareholders filing any amended returns and making such adjustments that
are necessary to properly reflect the reporting of X’s items of S corporation income.
Specifically, Trust must file an amended return and make adjustments that are
necessary to properly reflect the treatment of Trust as an ESBT for Year taxable year.
PLR-132856-12 4

    Additionally, as an adjustment under § 1362(f), a payment of $n and a copy of

this letter ruling must be sent to the following address: Internal Revenue Service,
Cincinnati Service Center, 201 West Rivercenter Blvd., Covington, KY 41011, Stop 31,
Terri Lackey, Manual Deposit. This letter must be sent no later than Date 4.

   A copy of this letter must be attached to any income tax return to which it is

relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.

    If all of the above conditions are not met, then this ruling is null and void.

Furthermore, if these conditions are not met, X must notify the Cincinnati Service Center
that its S corporation election has terminated.

     Except for the specific ruling above, no opinion is expressed or implied

concerning the federal tax consequences of the facts of this case under any other
provision of the Code. Specifically, no opinion is expressed or implied regarding X’s
eligibility to be an S corporation or Trust’s eligibility to be an ESBT.

  The rulings contained in this letter are 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 request for rulings, it is subject to verification on
examination.

  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.

    Under a power of attorney on file with this office, we are sending a copy of this

letter to your authorized representatives.

                                    Sincerely,


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

Enclosures (2):

   A copy of this letter
   A copy for § 6110 purposes

cc: