Corporation receives relief after trust misses ESBT election

Plain-English summary

A corporation's S election was ineffective because a shareholder trust did not timely elect to be an electing small business trust and was therefore an ineligible shareholder. The corporation represented that the trust had always met the substantive ESBT requirements and that the missed election was inadvertent, not tax-motivated. The corporation and its shareholders also agreed to make any adjustments required for consistent S corporation treatment. The IRS granted relief under section 1362(f) and treated the corporation as an S corporation from the intended effective date. The relief was conditioned on filing the ESBT election and all required original or amended open-year returns within 120 days.

Ruling snapshot

• Question: Could the corporation receive relief for an inadvertently ineffective S election caused by a trust's missed ESBT election?
• Outcome: Approved, subject to filing the ESBT election and consistent returns within 120 days.
• Key authorities: IRC §§ 1361(e) and 1362(f); Treas. Reg. § 1.1361-1(m).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201811001
Third Party Communication: None
Release Date: 3/16/2018
Date of Communication: Not Applicable
Index Number: 1361.03-03, 1362.02-02,
1362.04-00
Person To Contact:
-------------------, ID No. ------------------
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Telephone Number:
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------------------------------------------ Refer Reply To:
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CC:PSI:B01
PLR-114232-17
Date:
October 27, 2017

LEGEND

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

Trust = ------------------------------------------
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A = ----------------

Date = --------------------

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

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

This responds to a letter dated March 31, 2017, and supplemental information, submitted on behalf of X by X’s authorized representative, requesting relief under section 1362(f) of the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations within, X was incorporated on Date, under the laws of State. Effective Date, X elected to be taxed as an S corporation. However, an Electing Small Business Trust (ESBT) election effective Date was not timely filed for Trust, a shareholder of X. Accordingly, Trust was an ineligible shareholder of X and X’s S corporation election was ineffective.

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X represents that Trust has at all times since Date met the requirements of an ESBT within the meaning of § 1361(e). X represents that its ineffective S corporation election was inadvertent and was not motivated by tax avoidance or retroactive tax planning. Further, X represents that X and its shareholders agree to make any adjustments required as a condition of obtaining relief for its ineffective election as provided under
§ 1362(f) of the Code that may be required by the Secretary.

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.

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)(v) provides that, for purposes of § 1362(b)(1)(B), an electing small business trust (ESBT) may be an S corporation shareholder.

Section 1361(e) provides that an ESBT 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)(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)(1)(B) provides that the term “electing small business trust” shall not include (i) any qualified subchapter S trust (as defined in § 1361(d)(3)) if an election under § 1361(d)(2) applies to any corporation the stock of which is held by such trust, (ii) any trust exempt from tax under subtitle A, and (iii) any charitable remainder annuity trust or charitable remainder unitrust (as defined in § 664(d)).

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) 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).

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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(f) provides, in relevant part, that if (1) an election under § 1362(a) by any corporation 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 was terminated under § 1362(d)(2) or (3); (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 so that the corporation for which the election was made or termination occurred is a small business corporation; and (4) the corporation for which the election was made or 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 the 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 ineffectiveness or termination, such corporation shall be treated as an S corporation 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 was inadvertently ineffective within the meaning of § 1362(f) on Date because Trust was an ineligible shareholder. Pursuant to the provisions of § 1362(f), X will be treated as an S corporation from Date and thereafter, provided X’s S corporation election is otherwise effective and not terminated under § 1362(d).

This letter ruling is contingent upon the following conditions being met within 120 days from the date of this letter: (1) an election to treat Trust as an ESBT effective Date, must be made with the appropriate service center; and (2) X and its shareholders must file any original and amended returns for all open taxable years consistent with the relief granted in this letter. A copy of this letter should be attached to the ESBT election. If these conditions are not met, then this ruling is null and void.

Except as specifically ruled upon above, we express or imply no opinion concerning the federal tax consequences of the facts of this case under any other provision of the Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S corporation.

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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 representatives.

Sincerely,

Faith P. Colson
Faith P. Colson
Senior Counsel, Branch 1
Office of the Chief Counsel
(Passthroughs & Special Industries)

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

cc: