Defective consents and missed ESBT election did not end S status

Plain-English summary

A corporation's S election was defective because trustees, instead of the grantors of several trusts, signed the shareholder consents. One trust also continued holding stock after the two-year period following a deemed owner's death without making an electing small business trust election. The IRS found both problems inadvertent and treated the corporation as continuously maintaining S status. The grantors had to file proper consents within 120 days. The affected trust also had to file an ESBT election effective when its temporary eligibility expired, within the same 120-day period.

Ruling snapshot

• Question: Could the corporation preserve S status despite defective shareholder consents and a missed ESBT election?
• Outcome: Approved, subject to corrective filings within 120 days
• Key authorities: IRC §§ 1361 and 1362(f)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201525004
Third Party Communication: None
Release Date: 6/19/2015
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-133962-14
Date January 6, 2015

LEGEND

X = ---------------------
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H = -------------------------------
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W = ----------------------------
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Trust A = ----------------------------------------------------------------------
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Trusts = ------------------------------------------------------------------------------------------
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D1 = ----------------------------

D2 = ---------------------------------

D3 = ---------------------------------

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

This letter responds to a letter dated September 11, 2014, and subsequent correspondence submitted on behalf of X requesting rulings under § 1362(f) of the Internal Revenue Code (Code).
PLR-133962-14
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FACTS

The information submitted states that X is a corporation that made an election to be treated as a subchapter S corporation effective D1. However, the trustee rather than the grantors of the Trusts signed the Form 2553, Election by a Small Business Corporation, to consent to X’s S corporation election. Therefore, the Trusts were not permitted shareholders. Also, the Form 2553 contained certain clerical errors insofar as the names of several shareholders who signed consents were misspelled and an individual rather than his estate was listed as a shareholder.

In addition, shares of stock in X are held by Trust A. Trust A was a grantor trust described in § 1361(c)(2)(A)(i) of which H and W were the deemed owners. H died on D2. Relative to H’s shares of X stock, Trust A qualified under § 1361(c)(2)(A)(ii) as an eligible shareholder for two years from H’s date of death. However, Trust A continued to hold the X stock after the two-year period. According to X, Trust A qualifies as an electing small business trust (“ESBT”), but its trustee made no ESBT election.

X represents that the circumstances resulting in any termination or ineffectiveness of its S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its respective 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) 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)(ii) provides that for purposes of § 1361(b)(1)(B), a trust which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed owner and which continues in existence after such death may be a shareholder, but only for the 2-year period beginning on the day of the deemed owner’s death.

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

Section 1362(a)(2) provides that an election under § 1362(a) shall be valid only if all persons who are shareholders in the corporation on the day on which the election is made consent to the election.

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 termination, the corporation will 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 the S corporation election of X was ineffective for the taxable year beginning D1, because of the failure of the grantors of the Trusts to properly consent to X’s S corporation election. We further conclude that the ineffectiveness of X’s S corporation election constituted an inadvertent invalid election within the meaning of § 1362(f). Accordingly, X will be treated as continuing to be an S corporation from D1 and thereafter, provided that its S corporation election was otherwise valid and was not otherwise terminated under § 1362(d), except as addressed below. We also conclude that the clerical errors on Form 2553 did not cause the election of X to be invalid.
PLR-133962-14
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As a condition to this ruling, proper consents signed by the grantors of the Trusts must be filed with the appropriate service center, indicating that the consents must be filed with the originally filed Form 2553 for X within 120 days of the date of this letter. A copy of this letter should be attached to the consents.

We further conclude that X’s S corporation election would have terminated on D3 (after the two-year period beginning on H’s death) due to the trustee’s failure to make an ESBT election for Trust A had the initial S election been valid. We also conclude that such termination would have constituted an inadvertent termination within the meaning of § 1362(f). Accordingly, X will be treated as continuing to be an S corporation from D3, and thereafter, provided that its S corporation election was otherwise valid and was not otherwise terminated under § 1362(d). Moreover, relative to H’s shares of X stock, Trust A will be treated as an ESBT from D3, and thereafter, provided the trustee of Trust A files an ESBT election for Trust A with the appropriate service center, effective D3, within 120 days of the date of this letter. A copy of this letter should be attached to each election.

Except as expressly provided herein, we express or imply no opinion concerning the federal 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 X is otherwise eligible to be treated as an S corporation.

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.

Pursuant to a power of attorney on file, we are sending a copy of this letter to X‘s authorized representative.

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/

Bradford R. Poston
Senior Counsel, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)
Enclosures (2)
Copy of this letter
Copy for § 6110 purposes