Corporation received inadvertent invalid S election relief

Plain-English summary

A corporation's S election was invalid because two shareholder trusts intended to qualify as electing small business trusts, but their trustees failed to file the required ESBT elections. The corporation and shareholders consistently filed as though the S election were valid, represented that the trusts always met the ESBT requirements, and agreed to make any required adjustments. The IRS found the failure inadvertent under section 1362(f) and treated the corporation as an S corporation from the intended effective date. The relief requires both trustees to file effective ESBT elections within 120 days.

Ruling snapshot

• Question: Could the corporation preserve its S status despite two trustees' failure to file timely ESBT elections?
• Outcome: Approved as an inadvertent invalid election, subject to filing both ESBT elections within 120 days.
• 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: 201431006 Third Party Communication: None
Release Date: 8/1/2014 Date of Communication: Not Applicable
Index Number: 1362.00-00
Person To Contact:
------------------------------------------------------------ -----------------, ID No. ------------------
--------------------------------------- Telephone Number:
--------------------------------- ----------------------
------------------------------------- Refer Reply To:
--------------------------------------- CC:PSI:B01
PLR-142868-13
Date:
April 11, 2014

Legend

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

B = -------------------------------

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

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

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

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

State = -------

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

    This responds to a letter dated October 16, 2013 and subsequent

correspondence, submitted on X’s behalf by X’s authorized representative, requesting
relief under § 1362(f) of the Internal Revenue Code.

FACTS
According to the information submitted, X was incorporated under the laws of
State on Date 1 and elected to be treated as an S corporation effective Date 2. B, Trust
1, and Trust 2 were shareholders of X on Date 2.

    X represents that Trust 1 and Trust 2 were eligible to be an ESBT within the

meaning of § 1361(e). However, the trustee of Trust 1 and the trustee of Trust 2 did not
make an election under § 1361(e)(3) to treat the trust as an ESBT. Therefore, Trust 1
and Trust 2 were not permissible shareholders and X’s S corporation election was
invalid.

   X represents that the circumstances resulting in a failure to file ESBT elections

for Trust 1 and Trust 2 were inadvertent and were not motivated by tax avoidance or
retroactive tax planning. X further represents that since Date 2, X and its shareholders
have filed returns consistent with X having a valid S election. X represents that Trust 1
and Trust 2 have at all times met the requirements of an electing small business trust.
Lastly, X and its shareholders have agreed to make such adjustments, consistent with
the treatment of X as an S corporation, as may be required by the Service.

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 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 §1361(b)(1)(B), an

electing small business trust (ESBT) may be a 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 an (I) individual, (II) an estate, (III)
an organization described in paragraph (2), (3), (4), or (5) of § 170(c), 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 this subsection applies to such trust.

   Section 1361(e)(1)(B) provides that an ESBT 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 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 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) (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 were inadvertent; (3) no later than a reasonable period of time after
discovery of the circumstances resulting in such ineffectiveness, steps were taken so
that the corporation for which the election was made is a small business corporation;
and (4) the corporation for which the election was made, 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,
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 corporation election was ineffective on Date 2 because the trustee of Trust 1
and the trustee of Trust 2 failed to make a timely ESBT election. We further conclude
that the ineffectiveness of X’s S corporation election was inadvertent within the meaning
of § 1362(f). Therefore, X will be treated as an S corporation effective Date 2 and
thereafter, provided that X’s S corporation election was otherwise valid and was not
otherwise terminated under § 1362(d).

   This ruling is contingent on the trustee of Trust 1 and the trustee of Trust 2 filing

an effective ESBT election effective Date 2, pursuant to the procedures set forth in §
1.1361-1(m)(2), 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, X’s shareholders, in determining their respective income tax

liabilities, must include their pro rata share of the separately stated and nonseparately
computed items of X as provided in § 1366, make any adjustments to stock basis as
provided in § 1367, and take into account distributions made by X as provided by §
1368.

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed or implied on whether X
was or is otherwise eligible to be treated as an S corporation or whether Trust 1 or Trust
2 was or is otherwise eligible to be treated as an ESBT.

  This ruling is directed only to the taxpayer requesting 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,


                                    Laura C. Fields
                                    Laura C. Fields
                                    Senior Technician Reviewer, Branch 1
                                    Office of the Associate Chief Counsel
                                    (Passthroughs & Special Industries)

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