Mistaken trust election does not end S corporation status

Plain-English summary

Stock of an S corporation was transferred to a trust that qualified to be an electing small business trust and was treated that way in practice. The trustee mistakenly filed a qualified subchapter S trust election even though the trust did not qualify as a QSST, and did not timely file the required ESBT election. That made the trust an ineligible shareholder and technically terminated the corporation's S election. The IRS found the termination inadvertent because it was not motivated by tax avoidance or retroactive planning and the corporation and shareholders had filed consistently with continued S status. The corporation would remain an S corporation if the trustee filed an ESBT election within 120 days, effective on the original stock-transfer date.

Ruling snapshot

• Question: Was the S corporation termination caused by the missing ESBT election inadvertent?
• Outcome: Approved. S status continues if the trustee files the ESBT election within 120 days.
• Key authorities: IRC §§ 1361(e) 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: 201438015
Third Party Communication: None
Release Date: 9/19/2014
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-148306-13
Date:
April 23, 2014

LEGEND

Company = --------------------------------------------------------------------------------------------
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Trust = --------------------------------------------------------------------------------------------
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State = -------------------

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

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

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

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

This letter responds to a letter dated November 25, 2013, submitted on behalf of Company by Company’s authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

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 on Date 3. Company represents that Trust was eligible to be an electing small business trust (ESBT) within the meaning of § 1361(e) and has been treated as though a timely ESBT election had been made. However, an election was mistakenly filed under § 1361(d)(2)
PLR-148306-13
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for Trust to be treated as a qualified subchapter S trust (“QSST”) effective Date 3, even though Trust did not qualify as a QSST and was, in fact, treated as an ESBT. The trustee of Trust made no election under § 1361(e)(3) to treat Trust as an ESBT. Therefore, Trust was not an eligible shareholder and, as a result, Company’s S corporation election terminated.

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. Additionally, Company represents that Company and its shareholders have filed their federal income tax returns consistent with having a valid S corporation election in effect for Company. Company and its shareholders have agreed to 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).

LAW

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 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.
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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 1.1361-1(m)(2)(iii) provides that the ESBT election must be filed within the same time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a QSST election (no later than 15 days and two months after the desired effective date).

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, in pertinent 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 in such corporation at any time 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.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that Company’s S corporation election terminated because the trustee of Trust 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 Company’s S corporation election was not otherwise terminated under § 1362(d) and provided that the trustee of Trust files 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 the ESBT election.

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 is eligible to be treated as an ESBT.
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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 a power of attorney on file with this office, we are sending copies of this letter to your authorized representatives.

The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.

Sincerely,

/s/

Holly Porter
Chief, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

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

cc: