Corporation keeps S status after missed ESBT election

Plain-English summary

A shareholder placed S corporation stock in a revocable grantor trust and later died. The trust remained an eligible S corporation shareholder for two years after the death, but its trustee failed to make a timely electing small business trust election when that period ended. The omission terminated the corporation's S election even though the corporation and trust continued filing consistently with S corporation and ESBT treatment. The IRS found that the termination was inadvertent and allowed S status to continue. Relief required the trustee to file an ESBT election effective on the termination date within 120 days.

Ruling snapshot

• Question: May the corporation retain S status after a trust holding its shares missed the ESBT election deadline?
• Outcome: Approved as an inadvertent termination, conditioned on filing the ESBT election within 120 days
• Key authorities: IRC §§ 1361(c)(2), 1361(e), and 1362(f); Treas. Reg. §§ 1.1361-1 and 1.1362-4

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201628014                                             Third Party Communication: None
Release Date: 7/8/2016                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                              Person To Contact:
-------------------------------------------------------       ---------------------------, ID No. ---------------
---------------------------                                   ----------------
--------------------------------------------                  Telephone Number:
-----------------------------------------                     --------------------
 ---------------------------                                  Refer Reply To:
                                                              CC:PSI:01
                                                              PLR-136227-15
                                                              Date:
                                                              March 29, 2016


Legend
X              =       ---------------------------------------------------------------------------------------------
                       ------------------------------------------------------
State          =       ------------
Date 1         =       ------------------------
Date 2         =       -------------------
Date 3         =       ---------------------
Date 4         =       -----------------------
Date 5         =       -----------------------
A              =       ----------------------
Trust          =       ---------------------------------------------------------------------------------------------
                       ------------------------------------------------------


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

      This responds to a letter dated October 30, 2015, and subsequent
correspondence submitted on behalf of X by X’s authorized representative, requesting
inadvertent termination relief under § 1362(f) of the Internal Revenue Code.

      The information submitted states that X was incorporated under the laws of State
on Date 1 and elected to be an S corporation effective Date 2. Pursuant to an
agreement dated Date 3, A established Trust, a revocable trust treated as a wholly-
owned grantor trust under §§ 671 and 676. A transferred shares of X stock to Trust.

       On Date 4, A died and Trust ceased to be a grantor trust with respect to A’s
interest, but continued to qualify as an eligible S corporation shareholder under
§ 1361(c)(2)(A)(ii) for the 2 year period beginning on the day of the deemed owner’s
death. X represents that the trust qualified to elect to be treated as electing small
business trust (ESBT), however, the trustee failed to make timely ESBT election within
PLR-136227-15                                 2

the meaning of § 1361(e)(1)(A)(v) thereby causing X’s S corporation election to
terminate on Date 5.

       X represents that the circumstances resulting in the termination of X’s S
corporation election were inadvertent and not motivated by tax avoidance. X further
represents that X filed returns consistent with X’s status as an S corporation. X also
represents that on Date 5 Trust qualified to be an ESBT and continues to qualify for to
be an ESBT. X further represents that Trust filed returns consistent with rules
applicable to ESBTs. X and its shareholders agree to make such adjustments
(consistent with the treatment of X as an S corporation) as may be required by the
Secretary.

        Section 1361(a)(1) 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)(B) provides that, for purposes of subchapter S, the term
“small business corporation” means a domestic corporation which is not an ineligible
corporation and which does not 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.

       Section 1361(c)(2)(A)(i) provides that, for purposes of § 1361(b)(1)(B), a trust all
of which is treated (under subpart E of part 1 of subchapter J of chapter 1) 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)(ii) and § 1.1361-1(b)(1)(ii) provide that, for purposes of
§ 1361(b)(1)(B), a trust that is described in § 1361(c)(2)(A)(i) immediately before the
death of the deemed owner and that continues in existence after such death is a
permitted S corporation shareholder, but only for the two-year period beginning on the
day of the deemed owner’s death. Section 1.1361-1(h)(3)(i)(B) provides that if stock is
held by a trust described in § 1.1361-1(h)(1)(ii), the estate of the deemed owner is
generally treated as the shareholder as of the day of the deemed owner’s death.

     Section 1361(c)(2)(A)(v) provides that for the purposes of § 1362(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
PLR-136227-15                                3

(iii) an election under § 1361(e) applies to such trust. Section 1361(e)(3) provides that
an election under § 1361(e) shall 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, in part, that
the trustee of the trust 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(d)(2) 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 that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (3), (2) the Secretary determines that
the circumstances resulting in such termination were inadvertent, (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
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 such 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 termination, such corporation shall be treated as an S
corporation during the period specified by the Secretary.

       Section 1.1362-4(b) provides, in relevant part, that for purposes of § 1.1362-4(a),
the determination of whether a termination was inadvertent is made by the
Commissioner. The corporation has the burden of establishing that under the relevant
facts and circumstances the Commissioner should determine that the termination was
inadvertent. The fact that the terminating event was not reasonably within the control of
the corporation and was not part of a plan to terminate the election, or the fact that the
terminating event or circumstance took place without the knowledge of the corporation,
notwithstanding its due diligence to safeguard itself against such an event or
circumstance, tends to establish that the termination was inadvertent.

       Section 1.1362-4(d) provides, in part, that the Commissioner may require any
adjustments that are appropriate. In general, the adjustments should be consistent with
the treatment of the corporation as an S corporation during the period specified by the
Commissioner.
PLR-136227-15                                 4

        Based solely on the facts submitted and representations made, we conclude that
X’s S corporation election terminated beginning on Date 5 because the trustee of Trust
failed to timely file the required ESBT election under § 1361(e)(1)(A)(v). We further
conclude that the termination was inadvertent within the meaning of § 1362(f) and X will
continue to be treated as an S corporation for the period from Date 5 provided that X’s S
corporation election was valid and was not otherwise terminated under § 1362(d).

        This ruling is conditioned upon the trustee of Trust filing an ESBT election
effective upon Date 5. The election must be filed with the appropriate service center
within 120 days of the date of this ruling. A copy of this letter should be attached to the
ESBT election.

        Except as expressly provided herein, we express or imply no opinion concerning
the 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 or whether Trust is eligible to be
treated as an ESBT. This ruling is directed only to the taxpayer requesting 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, a copy of this letter is being sent to X’s authorized
representative.

                                       Sincerely,


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

Enclosures (2)
 Copy of Letter
 Copy for 6110 purposes



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