Late ESBT elections receive inadvertent S termination relief

Plain-English summary

Shares of an S corporation passed through related corporate reorganizations and were transferred to two trusts. The trusts otherwise qualified as electing small business trusts, but their trustees failed to make timely ESBT elections, terminating the corporation's S status. The corporation, shareholders, and trusts consistently treated the corporation as an S corporation and the trusts as ESBTs, and the failure was not motivated by tax avoidance or retroactive planning. The IRS found the termination inadvertent under section 1362(f) and allowed continuous S status from the termination date. Each trustee must file a retroactive ESBT election within 120 days.

Ruling snapshot

• Question: Can the corporation retain S status after two shareholder trusts failed to timely elect ESBT treatment?
• Outcome: Approved, conditioned on both trustees filing retroactive ESBT elections 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: 201515013 Third Party Communication: None
Release Date: 4/10/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.01-00
Person To Contact:
----------------------------------- ----------------, ID No. ------------------
------------------------------------------ Telephone Number:
------------------------------------------ ----------------------
---------------------------------- Refer Reply To:
CC:PSI:B01
PLR-126294-14
Date:
December 08, 2014

LEGEND

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

Y = ----------------------------------

a = ----------

b = ----------

Trust1 = ----------------------------------------------------

Trust2 = --------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
-----
-----------

Trust3 = --------------------------------------------------------------------------------------------------

              -----------

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

Date 2= ----------------------
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Date 3= ----------------------

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

Date 5= -----------------

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

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

This responds to a letter dated July 3, 2014, and supplemental information, submitted
on behalf of X by X’s authorized representative, requesting inadvertent termination relief
under section 1362(f) of the Internal Revenue Code (Code). In addition, X also seeks
relief to allow Trust2 and Trust3 to file late elections to be treated as an electing small
business trust (ESBT) pursuant to section 1361(e) of the Code.

FACTS

According to the information submitted and representations within, X was incorporated
under the laws of State on Date 1. X elected to be treated as an S corporation on Date

2. On Date 3, all the shares of X were transferred to Y. As part of this transaction, Y
   elected to be treated as an S corporation and made an election to treat X as a Qualified
   Subchapter S Subsidiary (QSub), effective Date 3. X represents that this transaction
   was a mere change in identity and qualified as a reorganization under § 368(a)(1)(F).
   At the time of the reorganization, a shares of Y were owned by Trust1.

On Date 4, the a shares of Y, b shares each, were transferred to Trust2 and Trust3. On
Date 5, Y was merged into X and the Y shares were replaced with X shares; thus X was
the continuing corporation. X represents that this transaction was a mere change in
identity and therefore qualified as a reorganization under § 368(a)(1)(F). X succeeded
to Y’s prior S corporation status.

A timely election to treat Trust2 and Trust3 each as an Electing Small Business Trust
(ESBT) was not made, causing an inadvertent termination of X’s S corporation status
effective Date 4.

X represents that Trust2 and Trust3 have at all times met the requirements of an ESBT
except that the trustees of Trust2 and Trust3 did not make timely ESBT elections under
§1361(e)(3). In addition, X represents that X and its shareholders have treated X as an
S corporation at all relevant times, and that Trust2 and Trust3 have each been treated
as an ESBT since Date 4.
PLR-126294-14 3

X represents that the failure to file ESBT elections for Trust2 and Trust 3 was
inadvertent and was not motivated by tax avoidance or retroactive tax planning.
Further, X represents that X and its shareholders agree to make any adjustments
(consistent with the treatment of X as an S corporation) that may be required by the
Secretary.

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 ESBT may
be an S corporation 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 (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)(1)(B) provides that an ESBT does 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) of the Income Tax Regulations 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
PLR-126294-14 4

§ 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) for filing a QSST
election (generally within the 16-day-and-2-month period beginning on the day that the
stock is transferred to the trust).

Section 1362(d)(2) provides that (A) an election under subsection (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; and (B) any termination under this paragraph shall be effective on
and after the date of cessation.

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 or
termination were inadvertent; (3) no later than a reasonable period of time after
discovery of the circumstances resulting in such ineffectiveness or 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 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 or 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 the representations made, we conclude that
X’s S election terminated on Date 4 because of the failure to timely file an ESBT
elections for Trust2 and Trust3. We further conclude that the termination of X’s S
election was inadvertent within the meaning of § 1362(f). Therefore, X will be treated as
an S corporation effective Date 4 and thereafter, provided X’s S corporation election is
otherwise valid and not otherwise terminated under § 1362(d).

This ruling is contingent on the trustees of Trust2 and Trust3 filing with the appropriate
service center, within 120 days from the date of this letter, elections to treat Trust2 and
Trust3 as an ESBT effective Date 4. A copy of this letter should be attached to the
ESBT elections.

Except as specifically ruled upon above, we express or imply no opinion concerning the
PLR-126294-14 5

federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation, or whether Trust2 and Trust3 otherwise qualify as valid ESBTs.

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.

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to your authorized representatives.

                                  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 section 6110 purposes