Corporation receives inadvertent S election termination relief

Plain-English summary

An S corporation's stock was transferred to two trusts that qualified in substance as electing small business trusts, but the trustees did not make the required ESBT elections. The trusts were therefore ineligible shareholders, causing the corporation's S election to terminate. The IRS accepted the corporation's representation that the failure was inadvertent, was not motivated by tax avoidance or retroactive planning, and had been reported consistently with continued S corporation status. It ruled that the corporation would be treated as continuously qualifying as an S corporation if the corporation and shareholders maintained that treatment and the trustees filed retroactive ESBT elections within 120 days. The ruling did not decide whether the corporation or trusts otherwise met all applicable eligibility requirements.

Ruling snapshot

• Question: Could the corporation obtain inadvertent-termination relief after two trusts failed to file timely ESBT elections?
• Outcome: approved, subject to retroactive ESBT elections and consistent tax treatment
• Key authorities: IRC §§ 1361(e), 1362(d), and 1362(f)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201710022 Third Party Communication: None
Release Date: 3/10/2017 Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.01-02,
1362.02-00, 1362.02-02, Person To Contact:
1362.04-00, 1362.00-00 ----------------------------,
ID No. ------------------
------------------------------ Telephone Number:
--------------------------------------------- ----------------------
-------------------------------- Refer Reply To:
---------------------------------------- CC:PSI:B01
PLR-130924-16
Date:
November 17, 2016

LEGEND

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

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

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

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

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

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

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

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

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

Dear --------------:
PLR-130924-16 2

    This responds to a letter dated September 22, 2016, and subsequent

correspondence, submitted on behalf of X by X's authorized representative, requesting
relief under § 1362(f) of the Internal Revenue Code (the Code).

FACTS

   According to the information submitted, X was incorporated under the laws of

State on Date 1. X elected to be treated as an S corporation effective Date 2. On Date
3, stock in X was transferred to Trust 1 and Trust 2. X represents that Trust 1 and
Trust 2 have, at all times since Date 3, met the requirements to be Electing Small
Business Trusts (ESBTs), within the meaning of § 1361(e). However, no election was
made under § 1361(e)(3) to treat the trusts as ESBTs. Consequently, Trust 1 and Trust
2 were ineligible shareholders, and, as a result, X's S corporation election terminated on
Date 3. On Date 4, Trust 1 and Trust 2 transferred all their X stock to A, an eligible S
corporation shareholder.

   X 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 represents that it has filed its federal income tax returns
consistent with having a valid S corporation election in effect. Additionally, for each
year since Date 3, Trust 1 and Trust 2 have filed an original or amended return
consistent with being an ESBT. X and its shareholders, including Trust 1 and Trust 2,
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) 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 that is not an ineligible corporation and that 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 one
class of stock.

 Section 1361(c)(2)(A)(v) provides that, for the purposes of § 1362(b)(1)(B), an

ESBT is a permitted shareholder of a small business corporation.

  Section 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except

as provided in § 1362(e)(2)(B), the term “electing small business trust” means any trust
PLR-130924-16 3

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.

   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 1362(d)(2)(A) provides that an election under § 1362(a) shall be

terminated whenever the corporation ceases to be a small business corporation.

   Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a)

by any corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 termination, steps were taken so that the corporation is once
more a small business corporation, 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 any adjustments (consistent with the treatment of the
corporation as an S corporation) as may be required by the Secretary with respect to
the period, then, notwithstanding the circumstances resulting in the termination, the
corporation will be treated as continuing to be an S corporation during the period
specified by the Secretary.

CONCLUSION

   Based solely on the information submitted and the representations made, we

conclude that X's S election terminated on Date 3 when Trust 1 and Trust 2 became
shareholders, and that the termination was inadvertent within the meaning of § 1362(f).
Therefore, X will be treated as continuing to be an S corporation from Date 3, and
thereafter, provided that X's S corporation election was otherwise valid and was not
otherwise terminated under § 1362(d).

   This ruling is contingent upon X and all of its shareholders treating X as having

been an S corporation, and Trust 1 and Trust 2 as having been ESBTs, for the period
beginning Date 3, and thereafter. Within 120 days from the date of this letter, the
trustee of Trust 1 and Trust 2 must file an election to treat the trusts as ESBTs, effective
Date 3, with the appropriate service center. A copy of this letter should be attached to
the election. If these conditions are not met, then this ruling is null and void.
PLR-130924-16 4

     Accordingly, X's shareholders, in determining their respective income tax

liabilities, must include their pro rata share of the separately and non-separately
computed items of X as provided in § 1366, make any adjustments to stock basis as
provided in § 1367, and take into account distributions made by X as provided by
§ 1368.

    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 this letter. Specifically, no opinion is expressed concerning whether X is
otherwise eligible to be treated as an S corporation, or whether Trust 1 and Trust 2 are
eligible to be treated as ESBTs.

  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 § 6110 purposes