Missed ESBT election did not end S corporation status

Plain-English summary

A grantor trust continued holding S corporation stock after the two-year period following one deemed owner's death. The trust qualified to be an electing small business trust, but its trustee did not file the required ESBT election. The IRS found the resulting S corporation termination inadvertent and treated the corporation as continuously maintaining S status. The trust would be treated as an ESBT from the termination date if its trustee filed an effective election within 120 days and attached a copy of the ruling.

Ruling snapshot

• Question: Could the corporation preserve S status after a trust missed its ESBT election?
• Outcome: Approved, subject to an ESBT election 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: 201525005 Third Party Communication: None
Release Date: 6/19/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
--------------------------- -----------------------, ID No. -------------------
------------------------------------------------------ ---------------------------------------------------
--------------------------------- Telephone Number:
-------------------------- ----------------------
Refer Reply To:
CC:PSI:B03
PLR-133963-14
Date January 6, 2015

                                                LEGEND

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

H = ----------------------------

W = -------------------------

Trust A = -------------------------------------------------------------------

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).

                                                   FACTS

   The information submitted states that X is a corporation that made an election to

be treated as a subchapter S corporation effective D1. Shares of stock in X are held by
PLR-133963-14 2

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 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.

     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.
PLR-133963-14 3

    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

X’s S corporation election 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. We also
conclude that the termination 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.
PLR-133963-14 4

   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