Missing ESBT and QSST elections do not end S corporation status

Plain-English summary

A corporation’s S election was ineffective because one shareholder trust did not timely elect electing small business trust status. A second shareholder trust later failed to make a qualified subchapter S trust election, which would have terminated S status if the original election had been effective. The IRS found both failures inadvertent under IRC § 1362(f) and allowed the corporation to continue to be treated as an S corporation. Relief was conditioned on filing both trust elections within 120 days, correcting the trusts’ returns, making a required payment, and satisfying the letter’s other deadlines, with the ruling becoming void if the conditions were not met.

Ruling snapshot

• Question: Can the corporation retain S status despite missing ESBT and QSST elections for shareholder trusts?
• Outcome: Approved
• Key authorities: IRC §§ 1361(c), 1361(d), 1361(e), 1362(f); Treas. Reg. §§ 1.1361-1(m)(2), 1.1362-4(d)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201601002 Third Party Communication: None
Release Date: 12/31/2015 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
-------------------------------- -------------------------------- -------------
--------------------------- Telephone Number:
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------------------------------- Refer Reply To:
CC:PSI:B01
PLR-109694-15
Date:
September 11, 2015

LEGEND:

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

B = -------------------------------------------------------------------------------------------------------------------
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Trust 1 = -------------------------------------------------------------------------------------------------------------------
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Trust 2 = -------------------------------------------------------------------------------------------------------------------
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State = ------

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

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

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

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

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

Date 6 = -----------------------
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PLR-109694-15 2

Years =
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$n =

Dear------------------

This responds to a letter dated February 22, 2015, and subsequent correspondence,
submitted on behalf of X, requesting relief pursuant to § 1362(f) of the Internal Revenue
Code (the Code).

Facts

The information submitted states that X was incorporated under the laws of State on
Date 1. X filed a timely election under § 1362(a) to be taxed as an S corporation
effective Date 2. On Date 2, Trust 1 owned shares of X stock. X represents that Trust 1
was qualified to be an Electing Small Business Trust (ESBT), within the meaning of
§ 1361(e). However, no election was made under § 1361(e)(3) to treat Trust 1 as an
ESBT. Consequently, Trust 1 was an ineligible shareholder, and, as a result, X’s S
corporation election was ineffective.

Additionally, on Date 2, A, an individual, owned shares of X stock. On Date 3, A
contributed the shares of X stock to Trust 2, a revocable trust. A died on Date 4.
Pursuant to the terms of Trust 2, after A’s death, individual B became the primary
beneficiary of Trust 2. X represents that Trust 2 is eligible to elect to be a qualified
subchapter S trust (QSST). However, no QSST election was filed on behalf of Trust 2
and therefore X’s S corporation election would have terminated on Date 5 (if it had not
already made an ineffective election) because Trust 2 was an ineligible shareholder.

X represents that the circumstances resulting in the ineffectiveness of X's S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. Additionally, X represents that X and its shareholders have filed their federal
income tax returns consistent with having a valid S corporation election in effect for X.
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 Secretary
with respect to the period specified by § 1362(f).

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.
PLR-109694-15 3

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)(i) provides that, for the purposes of §1362(b)(1)(B), a trust all of
which is treated (under title 26, subtitle A, chapter 1, subchapter J, part I, subpart E of
the United States Code) as owned by an individual who is a citizen or resident of the
United States may be a shareholder of an S corporation.

Section 1361(c)(2)(A)(v) provides that an ESBT, within the meaning of § 1361(e)(1),
may be a shareholder for purposes of § 1361(b)(1)(B). The trustee of the trust makes
the ESBT election pursuant to § 1361(e)(3). 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 1361(d)(1) provides that, in the case of a QSST with respect to which a
beneficiary makes an election under § 1361(d)(2), (A) such trust will be treated as a
trust described in § 1361(c)(2)(A)(i), and (B) for purposes of § 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 § 1361(d)(2) is made.

Section 1361(d)(2)(A) provides that a beneficiary of a QSST (or his legal representative)
may elect to have § 1361(d) apply. Section 1361(d)(2)(D) provides that an election
under § 1361(d)(2) shall be effective up to 15 days and 2 months before the date of the
election.

Section 1362(f) provides that if (1) an election under § 1362(a) by any corporation (A)
was not effective for the tax 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 paragraph (2) or (3) of § 1362(d); (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 event resulting in the ineffectiveness, steps were taken (A) so that the
corporation is a small business corporation, or (B) to acquire the required 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 such ineffectiveness, the corporation
shall be treated as an S corporation during the period specified by the Secretary.
PLR-109694-15 4

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 representation made, we conclude X’s S
election was invalid on Date 2 upon the failure to timely file an ESBT election for
Trust 1. We further conclude that the invalid election was inadvertent within the
meaning of § 1362(f). Pursuant to the provisions of § 1362(f), X will continue to be
treated as an S corporation on and after Date 2, unless X’s S corporation is otherwise
terminated under § 1362(d). Moreover, had X’s S corporation been effective, it would
have terminated on Date 5 upon the failure of the income beneficiary to file a QSST
election for Trust 2. Similarly, this terminating event would have been an inadvertent
termination within the meaning of § 1362(f).

This ruling is conditioned on: 1) the trustee of Trust 1 filing an ESBT election effective
Date 2 with the appropriate service center within 120 days of the date of this letter, and
2) B, as the income beneficiary of Trust 2, filing a QSST election for Trust 2 effective
Date 5 within 120 days from the date of this letter. A copy of this letter should be
attached the ESBT and QSST elections.

In addition, this ruling is conditioned on: 1) Trust 1 filing any amended returns and
making adjustments that are necessary to properly reflect the treatment of Trust 1 as an
ESBT for Years taxable years, and 2) Trust 2 filing any amended returns and making
adjustments that are necessary to properly reflect the treatment of Trust 2 as a QSST
for Years taxable years.

Furthermore, as an adjustment under § 1362(f)(4), this ruling is conditioned on the
payment of $n and a copy of this letter ruing must be sent to the address: Internal
Revenue Service, Cincinnati Service Center, 201 West Rivercenter Blvd., Covington,
KY 41011, Stop 31, Terri Lackey, Manual Deposit. The payment and 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 was filed.

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.
PLR-109694-15 5

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

                                    Sincerely,



                                    Laura C. Fields
                                    Senior Technician Reviewer, Branch 1
                                    (Passthroughs & Special Industries)

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