Corporation kept S status despite two trusts' missing ESBT elections

Plain-English summary

A corporation elected S corporation status while two shareholder trusts failed to make timely and effective electing small business trust elections. That failure made the corporation's S election ineffective. The corporation and its shareholders had consistently filed as though the election were effective, represented that the omission was not driven by tax avoidance or retroactive planning, and agreed to any required adjustments. The IRS treated the ineffectiveness as inadvertent and ruled that the corporation would be treated as an S corporation from the intended effective date, assuming it otherwise remained eligible. The relief required the trusts' trustee to file both ESBT elections within 120 days of the ruling.

Ruling snapshot

• Question: Could the corporation receive inadvertent-election relief after two shareholder trusts failed to make timely ESBT elections?
• Outcome: Approved. The corporation retained S treatment and the trusts received ESBT treatment from the intended effective date, subject to timely corrective elections.
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201426021
Third Party Communication: None
Release Date: 6/27/2014
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------------- ---------------------, ID No. ----------------
-------------------------------------------------- Telephone Number:
------------------------------------------ --------------------
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Refer Reply To:
CC:PSI:B02
PLR-148854-13
Date:
January 30, 2014

Legend

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

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

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

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

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

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

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

This responds to a letter dated November 25, 2013 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 formed in State on Date 1, and made an election to be treated as an S corporation effective Date 2. Trust 1 and Trust 2 held shares in X prior to Date 2. However, Trust 1 and Trust 2 failed to make timely and effective electing small business trust (ESBT) elections. Therefore, X’s S corporation election was ineffective.

X represents that X and each of its shareholders have filed consistently with the treatment of X as an S corporation since Date 2. X further represents that the failure to properly file the ESBT elections for Trusts 1 and 2 were not motivated by tax avoidance

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2

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(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)(B) provides that 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(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as provided in § 1362(e)(2)(B), 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 PCB, (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.

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 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall be terminated whenever (at any time on or after the first day of the first taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation and (B) any termination under § 1362(d)(2) shall be effective on and after the date of cessation.

Section 1362(f) provides 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

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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 X’s election as an S corporation was ineffective and that this was inadvertent within the meaning of § 1362(f). We further conclude that, pursuant to the provisions of § 1362(f), X will be treated as being an S corporation from Date 2 and thereafter, provided that X is otherwise eligible to be an S corporation and provided that the election was not otherwise terminated under § 1362(d). Trust 1 and Trust 2 will be treated as ESBTs from Date 2 and thereafter.

This ruling is conditioned upon the trustee of Trusts 1 and 2 filing, with the appropriate service center, ESBT elections effective Date 2 for Trust 1 and Trust 2. The ESBT elections must be filed within 120 days following the date of this letter and a copy of this letter should be attached to the election.

Except as specifically ruled above, we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the Code. Specifically, we express no opinion regarding X’s eligibility to be an S corporation or the validity of its S corporation election. We express no opinion on whether Trust 1 or Trust 2 qualify as ESBTs within the meaning of § 1361(e).

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.

In accordance with the power of attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

Bradford Poston
Senior Counsel, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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