Late ESBT election does not end S corporation status

Plain-English summary

An irrevocable trust held S corporation shares and initially qualified as a grantor trust. When the grantor relinquished retained powers, the trust ceased being a grantor trust but otherwise represented that it qualified as an electing small business trust. The trustee failed to timely make the ESBT election, which caused the corporation's S election to terminate. The IRS found the termination inadvertent and allowed the corporation to continue S treatment from the termination date. The relief required the trustee to file an ESBT election effective on that date within 120 days, or the ruling would become void.

Ruling snapshot

• Question: Could the corporation preserve S status after a shareholder trust failed to make a timely ESBT election?
• Outcome: Approved, conditioned on filing the ESBT election within 120 days.
• Key authorities: IRC §§ 1361(e) and 1362(d) and (f).

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201636013                                              Third Party Communication: None
Release Date: 9/2/2016                                         Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
                                                               Person To Contact:
--------------------------                                     -----------------------, ID No. ----------------
---------------------------------------------------------      Telephone Number:
------------------                                             --------------------
-----------------------------                                  Refer Reply To:
                                                               CC:PSI:B03
                                                               PLR-106114-16
                                                               Date:
                                                               May 17, 2016


LEGEND

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

Trust1            =         -----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------
-------------------------------------------------

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

State1            =        --------------

State2            =        ------------

Date1             =        ---------------------

Date2             =        --------------------

Date3             =        --------------------------

Date4             =        ----------------------

Year              =        ------

N1                =        -----
PLR-106114-16                               2

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

       This responds to a letter dated February 22, 2016, submitted on behalf of X by
X’s authorized representative, requesting a ruling under § 1362(f) of the Internal
Revenue Code (the Code).

       The information submitted states that X was incorporated under the laws of
State1 in Year. X merged into another State2 corporation on Date1. X elected to be an
S corporation effective Date2. A established Trust as an irrevocable trust on Date3 and
transferred N1 shares of X to Trust on Date3. X represents that Trust was properly
treated as a grantor trust for purposes of §§ 671-677 of the Code from Date3 until
Date4, when A relinquished the powers over Trust that A had previously retained. X
further represents that Trust ceased being a grantor trust on Date4, but otherwise met
the requirements to be an electing small business Trust (“ESBT”) beginning Date4.
However, the trustee of Trust failed to timely file the election under § 1361(e) to treat
Trust as an ESBT effective Date4.

       X represents that X and all of X’s shareholders have filed tax returns consistent
with X being an S corporation since Date2. In addition, X represents that Trust has filed
tax returns consistent with its treatment as an ESBT since Date4. X further represents
that the circumstances resulting in the termination of X’s S corporation election were
inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and
its shareholders have agreed to make such adjustments consistent with the treatment of
X as an S corporation as may be required by the Secretary.

       Section 1362(f) provides that if (1) an election under § 1362(a) by a 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.

       Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date4 as the result of the failure of the
trustee Trust to make an election under § 1362(1) to treat Trust as an ESBT effective as
PLR-106114-16                                 3

of that date. We further conclude that the termination of X’s S corporation election on
Date4 was inadvertent within the meaning of § 1362(f). We further hold that, pursuant
to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from
Date4 and thereafter, provided that X’s S corporation election was valid and provided
that the election was not otherwise terminated under § 1362(d).

       This ruling is contingent upon the trustee of Trust filing an ESBT election on
behalf of Trust with an effective date of Date4. This 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 election.

       If the above condition is not met, then this letter ruling is null and void.
Furthermore, if this condition is not met, X must send a notification that its S election
has terminated to the service center with which X’s S election was filed.

       Except as specifically set forth above, no opinion is expressed concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed regarding X’s eligibility to be an S
corporation or the validity of its S corporation election. Further, no opinion is expressed
as to whether Trust qualifies as an ESBT or previously qualified as a grantor trust.

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

      The rulings contained in this letter are 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 request for rulings, it is subject to verification on
examination.
PLR-106114-16                               4


      In accordance with the power of attorney on file with this office, we are sending a
copy of this letter to X’s authorized representative.

                                     Sincerely,


                                     Bradford R. Poston
                                     Senior Counsel, Branch 3
                                     Office of Associate Chief Counsel
                                     (Passthroughs & Special Industries)

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


cc: