S corporation election reinstated after missed ESBT elections

Plain-English summary

An S corporation's stock was transferred to two trusts whose trustees did not timely file the elections required for electing small business trusts. Because the trusts were not eligible shareholders without those elections, the corporation's S corporation election terminated. The IRS determined that the termination was inadvertent and allowed the corporation to continue being treated as an S corporation from the termination date if both trustees filed the required elections within 120 days. The ruling did not decide whether the corporation otherwise qualified as an S corporation or whether the trusts were eligible ESBTs.

Ruling snapshot

• Question: Could the corporation's S election continue after the trusts missed their ESBT elections?
• Outcome: Approved, subject to timely corrective elections.
• Key authorities: IRC §§ 1361 and 1362; Treas. Reg. §§ 1.1361-1(m)(2) and 1.1362-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201407003 Third Party Communication: None
Release Date: 2/14/2014 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------- ---------------------------, ID No. ---------------
----------------------------------- -----------------
---------------------------------- Telephone Number:
------------------------------------ --------------------
Refer Reply To:
CC:PSI:02
PLR-120248-13
Date:
August 29, 2013

Legend
Company = ------------------------------------------------------------------------------------------------
-----------------------------
State = ---------------
Date 1 = ------------------
Date 2 = ---------------
Date 3 = ---------------------
Trust 1 = ------------------------------------------------------------------------------------------------
---------------------------
Trust 2 = ------------------------------------------------------------------------------------------------
--------------------------

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

  This letter responds to a letter dated April 26, 2013, and subsequent

correspondence, submitted on behalf of Company by Company's authorized
representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

    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 1 and Trust 2 on
Date 3. Company represents that Trust 1 and Trust 2 were eligible to be electing small
business trusts (ESBTs) within the meaning of § 1361(e) and have been treated as
though timely ESBT elections had been made. However, the trustees of Trust 1 and
Trust 2 made no election under § 1361(e)(3) to treat Trust 1 and Trust 2 as ESBTs.
Therefore, Trust 1 and Trust 2 were not eligible shareholders, and, as a result,
Company's S corporation election terminated on Date 3.

  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

PLR-120248-13 2

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).

    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
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

PLR-120248-13 3

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.

   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 1 and Trust 2, because the trustees of Trust 1 and Trust 2 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 trustees of Trust 1 and Trust 2 each file 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 each ESBT election.

PLR-120248-13 4

    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 1 or Trust 2 are
eligible to be treated as an ESBT. This ruling is directed only to the taxpayer requesting
it. Section 6110(k)(3) of the Code 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
Company’s authorized representative.

                                  Sincerely,



                                  Bradford R. Poston
                                  Senior Counsel, Branch 2
                                  (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes