S corporation receives relief after a trust misses its ESBT election

Plain-English summary

After a shareholder died, shares of an S corporation passed under the shareholder's will to a trust. The trust could hold the shares for two years without an election, but its trustee failed to elect electing small business trust status before that period ended, terminating the corporation's S election. The IRS found the termination inadvertent and ruled that the corporation would continue to be treated as an S corporation. Relief was conditioned on a timely ESBT election, any necessary amended trust returns and adjustments, and payment of a redacted amount by the specified deadline.

Ruling snapshot

• Question: Was the S election termination caused by the trustee's failure to make a timely ESBT election inadvertent?
• Outcome: Approved, subject to the ESBT election, return adjustments, and required payment.
• Key authorities: IRC §§ 1361(c), 1361(e), and 1362(f); Treas. Reg. § 1.1362-4(d)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201519002 Third Party Communication: None
Release Date: 5/8/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
----------------------------------------------------- -------------------------, ID No. -----------------
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------------------------------------- Telephone Number:
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Refer Reply To:
CC:PSI:B3
PLR-122021-14
Date: November 24, 2014

LEGEND

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

Trust = -----------------------------------------------------------------
------------------------

A = ----------------------

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

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

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

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

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

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

Date 6 = ----------------------

$n = ------------------

Years = --------------------------
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Dear ----------------:

   This letter responds to a letter dated May 29, 2014, and subsequent

correspondence, submitted on behalf of X, requesting a ruling under § 1362(f) of the
Internal Revenue Code (Code).

FACTS

    The information submitted states that X was incorporated in State on Date 1 and

elected to be treated as an S corporation effective Date 2. On Date 3, A, a shareholder
in X died. Pursuant to the terms of A’s will, A’s estate transferred shares of X to Trust
on Date 4. Trust qualified under § 1361(c)(2)(A)(iii) as an eligible shareholder for a two-
year period beginning on the day shares of X were transferred to it. X represents that
Trust qualified as an electing small business trust (ESBT) within the meaning of
§ 1361(e). However, the trustee of Trust failed to make an election under § 1361(e)(3)
to treat Trust as an ESBT. As a result, X’s S corporation election terminated on Date 5
after the end of the two-year period described in § 1361(c)(2)(A)(iii).

   X represents that the failure to file the ESBT election for Trust and the resulting

termination of X’s S corporation election was not motivated by tax avoidance or
retroactive tax planning. X and its shareholders have agreed to make any adjustments
consistent with the treatment of X as an S corporation as may be required by the
Commissioner 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) provides, in part, 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(c)(2)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust

with respect to stock transferred to it pursuant to the terms of a will is a permitted
shareholder of an S corporation for the 2-year period beginning on the day on which
such stock is transferred to it.

   Section 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an ESBT

is a permitted shareholder of an S corporation.
+PLR-122021-14 3

    Section 1361(e)(1)(A) provides that except as provided in § 1361(e)(1)(B), the

term "electing small business trust" means any trust if -- (i) the trust does not have as a
beneficiary any person other than an individual, an estate, an organization described in
§ 170(c)(2), (3), (4), or (5), or an organization described in § 170(c)(1) that holds a
contingent interest in the trust and is not a potential current beneficiary; (ii) no interest in
the trust was acquired by purchase; and (iii) an election under § 1361(e) applies to the
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.

   Section 1362(d)(2)(A) provides that 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.

    Section 1362(f) provides, in part, 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
termination, the corporation will be treated as an S corporation during the period
specified by the Secretary.

  Section 1.1362-4(d) of the Income Tax Regulations provides that the

Commissioner may require any adjustments that are appropriate. In general, the
adjustments required should be consistent with the treatment of the corporation as an S
corporation during the period specified by the Commissioner.

CONCLUSION

     Based solely on the facts submitted and representations made, we conclude that

X's S corporation election was terminated on Date 5 when the trustee of the Trust failed
to file an ESBT election under § 1361(e)(3) for the Trust. We also conclude that the
+PLR-122021-14 4

termination of X’s S corporation election was inadvertent within the meaning of
§ 1362(f). Accordingly, under § 1362(f), X will be treated as continuing to be an S
corporation on and after Date 5, provided that X's S corporation election was valid and
not otherwise terminated under § 1362(d).

  This ruling is contingent on the trustee of Trust filing an ESBT election effective

Date 5 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.

  In addition, this ruling is contingent on Trust filing any amended returns and

making adjustments that are necessary to properly reflect the treatment of Trust as an
ESBT for Years taxable years.

    Furthermore, as an adjustment under § 1362(f), a payment of $n and a copy of

this letter ruling must be sent to the following address: Internal Revenue Service,
Cincinnati Service Center, 201 West Rivercenter Blvd., Covington, KY 41011, Stop 31,
Terri Lackey, Manual Deposit. The payment and a copy of this letter must be sent no
later than Date 6.

   If all of the above conditions are not met, then this ruling is null and void.

Furthermore, if these conditions are not met, X must send a notification that its S
corporation election has terminated to the service center with which X’s S corporation
election was filed.

   Except as specifically ruled above, we express no opinion concerning the federal

tax consequences of the facts of this case under any other provisions of the Code.
Specifically, we express no opinion as to whether X is otherwise eligible to be treated as
an S corporation or Trust is eligible to be treated as an ESBT.

   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.

   This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

of the Code provides that it may not be used or cited as precedent.
+PLR-122021-14 5

  In accordance with a power of attorney on file with this office, we are sending a

copy of this letter to your authorized representative.

                                 Sincerely,



                                 Mary Beth Carchia
                                 Senior Technician Reviewer, Branch 3
                                 Office of Associate Chief Counsel
                                 (Passthroughs & Special Industries)

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