Missed ESBT and QSST elections receive S corporation relief

Plain-English summary

An S corporation’s grantor-trust shareholder ceased to qualify after the grantor died, but the trustee did not timely elect ESBT status. Shares were later transferred to individuals and two trusts whose beneficiaries also missed timely QSST elections. The corporation and shareholders consistently intended and reported uninterrupted S status, and the failures were not motivated by tax avoidance or retroactive planning. The IRS found that the first omission terminated the S election and the later omissions would have caused another termination, but both were inadvertent. It allowed the corporation to continue as an S corporation if the ESBT and QSST elections and consistent amended returns were filed within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after its trust shareholders missed required ESBT and QSST elections?
• Outcome: Approved
• Key authorities: IRC §§ 1361(d), 1361(e), 1362(f); Treas. Reg. § 1.1361-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201545003 Third Party Communication: None
Release Date: 11/6/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.03-03
Person To Contact:
-------------------------------------- ---------------, ID No. ------------------
------------------------------------------------------- Telephone Number:
------------------------ ----------------------
-------------------------------------------- Refer Reply To:
CC:PSI:B01
PLR-104446-15
Date:
August 04, 2015

LEGEND

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

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

B = ----------------------------

C = --------------------

D = ------------------------

E = -------------------------

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

Trust 2 = ----------------------------------------------------

Trust 3 = -----------------------------------------------------

Date 1 = -------------------------
PLR-104446-15 2

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

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

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

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

Years = ---------------

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

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

This responds to a letter dated January 27, 2015, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code.

FACTS

According to the information submitted and representations within, X was incorporated
under the laws of State on Date 1. S elected to be treated as an S corporation effective
Date 2. On Date 2, Trust 1, a grantor trust, was an eligible shareholder of X. On Date
3, A, the grantor of Trust 1, died. As of Date 4, an Electing Small Business Trust
(ESBT) election was not timely filed for Trust 1, thereby causing Trust 1 to become an
ineligible shareholder of X.

On Date 5, shares in X were transferred from Trust 1 to B and C, both eligible
shareholders, and to Trust 2 and Trust 3. D and E, the beneficiaries of Trust 2 and Trust
3 respectively, failed to make timely Qualified subchapter S subsidiary (QSST)
elections.

X represents that Trust 1 intended to be an ESBT effective Date 4 and that Trust 2 and
Trust 3 intended to be QSSTs effective Date 5. However, a timely ESBT election was
not filed for Trust 1 and timely QSST elections were not filed for Trust 2 and Trust 3.

In addition, within the meaning of § 1361(d)(3), X represents that Trust 1 has at all times
met the requirements of an ESBT except that the trustee of Trust 1 did not make a
timely ESBT election under §1361(e)(3). X further represents that Trust 1 has not filed
its income tax returns consistent with being an ESBT for Years. X represents that Trust
2 and Trust 3 have qualified as QSSTs under § 1361(d) at all times, except that D and E
PLR-104446-15 3

failed to file timely QSST elections. X also represents that since Date 5, Trust 2 and
Trust 3 have filed their income tax returns consistent with being a QSST. X further
represents that X, its shareholders, and Trust 1’s beneficiaries, will amend their income
tax returns for Years within 120 days of the date of this ruling letter to reflect treatment
of Trust 1 as an ESBT.

X represents that the termination of its S election, and potential later termination of its S
election, was inadvertent and was not motivated by tax avoidance or retroactive tax
planning. X represents that, other than the failure to make a valid ESBT election on
Date 4 and valid QSST elections on Date 5, X has qualified as a small business
corporation at all times since its election on Date 2.

X represents that X and its shareholders have treated X as an S corporation at all
relevant times. X represents that the failure to file an ESBT election for Trust 1 and the
failure to file QSST elections for Trust 2 and Trust 3 were inadvertent and were not
motivated by tax avoidance or retroactive tax planning. X further represents that X has
filed its income tax returns consistent with having a valid S election in effect for all
taxable years since X elected to be an S corporation. Lastly, 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) that may be required by the
Secretary.

LAW AND ANALYSIS

Section 1361(a) provides that an S corporation is a small business corporation for which
an election under § 1362(a) is in effect.

Section 1361(b)(1) provides that the terms “small business corporation” means 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)(i) provides that, for purposes of section 1361(b)(1), a trust all of
which is treated (under subpart E of part I of subchapter J of this chapter) as owned by
an individual who is a citizen or resident of the United States may be an S corporation
shareholder.

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

Section 1361(d)(1) provides that, in the case of a qualified subchapter S trust with
respect to which a beneficiary makes an election under paragraph 1361(d)(2), such
PLR-104446-15 4

trust shall be treated as a trust described in subsection 1361(c)(2)(A)(i) and for
purposes of section 678(a), the beneficiary of such trust shall be treated as the owner of
that portion of the trust which consists of stock in an S corporation with respect to which
the election under paragraph 1362(d)(2) is made.

Section 1361(d)(3) defines the term “qualified subchapter S trust” as a trust all of the
income (within the meaning of section 643(b)) of which is distributed (or required to be
distributed) currently to one individual who is a citizen or resident of the United States.
In addition, the terms of the trust must require that (i) during the lifetime of the current
income beneficiary, there shall be only one income beneficiary of the trust, (ii) any
corpus distributed during the life of the current income beneficiary may be distributed
only to such beneficiary, (iii) the income interest of the current income beneficiary in the
trust shall terminate on the earlier of such beneficiary's death or the termination of the
trust, and (iv) upon the termination of the trust during the life of the current income
beneficiary, the trust shall distribute all of its assets to such beneficiary.

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
§ 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(a)(1) provides that except as provided in subsection (g), a small business
corporation may elect to be an S corporation. Section 1362(a)(2) provides that an
election under § 1362(a) shall be valid only if all persons who are shareholders in such
corporation on the day on which such election is made consent to such election.

Section 1362(d)(2)(A) provides that an election under § 1362(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.

Section 1362(f) provides, in relevant part, that if (1) an election under subsection (a) or
section 1361(b)(3)(B)(ii) by any corporation (A) was not effective for the taxable year for
which made (determined without regard to subsection (b)(2)) by reason of a failure to
PLR-104446-15 5

meet the requirements of section 1361(b) or to obtain shareholder consents, or (B) was
terminated under paragraph (2) or (3) of subsection (d) or section 1361(b)(3)(C); (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 (A) so that the corporation for which the election was made or the
termination occurred is a small business corporation or a qualified subchapter S
subsidiary, as the case may be, or (B) to acquire the required shareholder consents;
and (4) the corporation for which the election was made or the termination occurred,
and each person who was a shareholder in such corporation at any time during the
period specified pursuant to this subsection, agrees to make such adjustments
(consistent with the treatment of such corporation as an S corporation or a qualified
subchapter S subsidiary, as the case may be) 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 or
a qualified subchapter S subsidiary, as the case may be 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 no ESBT election was made for Trust 1.
Furthermore, if X’s S election had not terminated on Date 4, it would have terminated on
Date 5 because QSST elections were not filed for Trust 2 or Trust 3. We further
conclude that the termination on Date 4, and potential later termination on Date 5, 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 election is not
otherwise terminated under § 1362(d).

This letter ruling is subject to the following conditions. Within 120 days of the date of
this letter: (1) the trustee of Trust 1 must file an ESBT election under section 1361(e)(3)
for Trust 1, effective Date 4; (2) the beneficiaries of Trust 2 and Trust 3 must file a
QSST election under section 1361(d)(2)(A) for their respective trust, effective Date 5;
and (3) X, Trust 1, and Trust 1’s beneficiaries must amend or file returns for Years,
consistent with the treatment of Trust 1 as an ESBT.

These elections should be made with the appropriate service center within 120 days
from the date of this letter. A copy of this letter ruling should be attached to each
election. If these conditions are not met, then this ruling is null and void. Furthermore,
if these conditions are not met, X must send notification that its S election has
terminated to the service center with which X’s S election was filed.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
PLR-104446-15 6

this letter. Specifically, no opinion is expressed or implied concerning whether X
otherwise qualifies as an S corporation for federal tax purposes.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to the taxpayer’s authorized representative.

                                    Sincerely,


                                    Joy C. Spies
                                    Joy C. Spies
                                    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