Late ESBT election does not end S corporation status

Plain-English summary

Shares of an S corporation passed under a shareholder’s will to a trust that was eligible to hold S corporation stock for two years. When that period ended, the trust failed to make a timely electing small business trust election, causing the corporation’s S election to terminate. The corporation and trust had consistently filed as though the S and ESBT elections remained effective, and they represented that the failure was inadvertent. The IRS granted inadvertent termination relief and treated the corporation as continuing to be an S corporation, provided the trust filed an ESBT election within 120 days effective as of the termination date.

Ruling snapshot

• Question: Whether the missed ESBT election caused an inadvertent termination eligible for relief under section 1362(f)
• Outcome: Approved, subject to filing the ESBT election within 120 days
• Key authorities: I.R.C. §§ 1361, 1362(f); Treas. Reg. § 1.1361-1(m)(2)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201541003
Third Party Communication: None
Release Date: 10/9/2015
Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.02-03
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B01
PLR-104475-15
Date:
June 09, 2015

LEGEND

X = ----------------------------
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A = ----------------------

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

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

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

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

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

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

This responds to a letter dated January 8, 2015, submitted on behalf of X by X’s authorized representative, requesting relief under section 1362(f) of the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations within, X was incorporated on Date 1, under the laws of State. Effective Date 1, X elected to be taxed as an S
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corporation. A was a shareholder of X. On Date 2, A died. On Date 3, A’s shares of X stock were transferred Trust, pursuant to the terms of A’s will. Trust qualified under § 1361(c)(2)(A)(iii) as an eligible shareholder for a two-year period beginning on the day the shares of X were transferred to it. A timely election to treat Trust as an Electing Small Business Trust (ESBT) was not made, thus causing X’s S election to terminate on Date 4.

X represents that Trust has at all times met the requirements of an ESBT within the meaning of § 1361(d)(3). Throughout the period that Trust has been a shareholder of X, it has filed its federal income tax returns consistent with being an ESBT. X represents that X and its shareholders have filed consistently with X being an S corporation. X further represents that its S corporation election termination 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 required as a condition of obtaining relief under the inadvertent termination rule as provided under § 1362(f) of the Code that may be required by the Secretary.

LAW AND ANALYSIS

Section 1361(a)(1) of the Code 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)(iii) provides that a trust with respect to stock transferred to it pursuant to the terms of a will, but only 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 § 1362(b)(1)(B), an electing small business trust (ESBT) may be an S corporation shareholder.

Section 1361(e)(1)(A) 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 paragraph (2), (3), (4), or (5) of § 170(c), 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.
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Section 1361(e)(1)(B) provides that the term “electing small business trust” shall 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) 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 § 1.1361-1(m)(2)(ii).

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 inadvertently terminated within the meaning of § 1362(f) on Date 4.
Pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date 4 and thereafter, provided X’s S corporation election is not otherwise terminated under § 1362(d).

Within 120 days from the date of this letter, an election to treat Trust as an ESBT effective Date 4, must be made with the appropriate service center. A copy of this letter should be attached to the ESBT election.

Except as specifically ruled upon above, we express or imply no opinion concerning the federal tax consequences of the facts of this case under any other provision of the
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Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S corporation.

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 representative.

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