Restores two S elections after trusts missed ESBT filings

Plain-English summary

Two corporations lost their S corporation status after the owner of a grantor trust died and the trustee did not timely elect electing small business trust status when the post-death eligibility period ended. The first trust later distributed the corporate stock to a second trust, whose ESBT elections could not take effect because the corporations' S elections had already terminated. The IRS found both terminating events inadvertent and ruled that the corporations would continue to be treated as S corporations. Relief was conditioned on both trusts filing retroactive ESBT elections within 120 days, filing any needed amended returns and adjustments, and making a redacted payment by the specified date. The IRS did not rule that the corporations or trusts otherwise met all S corporation or ESBT eligibility requirements.

Ruling snapshot

• Question: Could two corporations receive inadvertent-termination relief after successive trusts failed to have effective ESBT elections?
• Outcome: Approved, subject to retroactive elections, return adjustments, and a required payment.
• Key authorities: IRC §§ 1361 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: 201832004                                              Third Party Communication: None
Release Date: 8/10/2018                                        Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                               Person To Contact:
----------------------------------------------                 ---------------------------------, ID No. ---------
------------------------------------------------------------   ------------------
-----------------------------------------------                Telephone Number:
------------                                                   ----------------------
--------------------------------------------                   Refer Reply To:
---------------------------------                              CC:PSI:01
                                                               PLR-133625-17
                                                               Date:
                                                               April 16, 2018




Legend
X                = -----------------------------------------------------------------------------------------------
                   --------------------------------------------------
State 1          = --------------
Date 1           = --------------------
Date 2           = -------------------
Y                = -----------------------------------------------------------------------------------------------
                   -----------------------------------
State 2          = --------------
Date 3           = --------------------------
Date 4           = ------------------
Date 5           = --------------------
Date 6           = --------------------
Date 7           = ----------------------
Date 8           = ----------------------
Date 9           = ----------------------
Date 10          = --------------------
A                = -----------------------------------------------------------------------------------------------
                   -------------------------------------
Trust 1          = -----------------------------------------------------------------------------------------------
                   -----------------------------------------------------------------------------------------------
                   ----------------------------------------------------------------------------------
Trust 2          = -----------------------------------------------------------------------------------------------
                   ----------------------------------
Years            = ---------------
N                = --------------
PLR-133625-17                                2


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

      This responds to a letter dated October 30, 2017, and subsequent
correspondence submitted on behalf of X and Y by their authorized representative,
requesting inadvertent termination relief under § 1362(f) of the Internal Revenue Code

                                         FACTS

       The information submitted states that X was incorporated under the laws of State
1 on Date 1 and elected to be an S corporation effective Date 2. The information further
states that Y was incorporated under the laws of State 2 on Date 3 and elected to be an
S corporation effective Date 4.

       Pursuant to an agreement originally dated Date 5 and which was last amended
and completely restated on Date 6, A established Trust 1, a revocable trust treated as a
wholly-owned grantor trust under §§ 671 and 676. A transferred shares of X and Y
stock to Trust 1.

       On Date 7, A died and Trust 1 ceased to be a grantor trust with respect to A’s
interests, but continued to qualify as an eligible S corporation shareholder under
§ 1361(c)(2)(A)(ii) for the two year period beginning on the day of the deemed owner’s
death. X and Y each represent that Trust 1 qualified to elect to be treated as an
electing small business trust (ESBT), however, the trustee failed to make timely ESBT
elections within the meaning of § 1361(e)(1)(A)(v) thereby causing X and Y’s respective
S corporation elections to terminate on Date 8.

       On Date 9, Trust 1 distributed the stock in X and Y to Trust 2, a residuary created
pursuant to the terms of Trust 1. X and Y represent that Trust 2 qualified to elect to be
treated as an ESBT and the trustee made timely ESBT elections within the meaning of
§ 1361(e)(1)(A)(v). However, because each of X and Y’s S corporation elections
terminated on Date 8, the ESBT elections were never valid.

       X and Y represent that the circumstances resulting in the termination of their
respective S corporation elections were inadvertent and not motivated by tax avoidance.
X and Y further represent that they each filed returns consistent with their status as S
corporations. X, Y, and their shareholders agree to make such adjustments (consistent
with the treatment of X and Y as S corporations) as may be required by the Secretary.

                                 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.
PLR-133625-17                                 3


       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
(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.
PLR-133625-17                                4

        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.

                                     CONCLUSION

       Based solely on the facts submitted and representations made, we conclude that
X and Y’s respective S corporation elections terminated beginning on Date 8 because
the trustee of Trust 1 failed to timely file the required ESBT elections under
§ 1361(e)(1)(A)(v). We further conclude that the circumstances resulting in such
terminations were inadvertent within the meaning of § 1362(f). Pursuant to the
provisions of § 1362(f), X and Y each will be treated as S corporations on and after Date
8, unless X and Y’s S corporation elections are otherwise terminated under § 1362(d).
Moreover, had X and Y’s respective S corporation elections been effective, their
respective elections would have terminated on Date 9 upon the failure of the trustee to
file ESBT elections 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 ESBT elections
effective Date 8 with the appropriate service center within 120 days of the date of this
PLR-133625-17                                5

letter, and 2) the trustee of Trust 2 filing ESBT elections for Trust 2 effective Date 9
within 120 days from the date of this letter. A copy of this letter should be attached the
ESBT elections.

       In addition, this ruling is conditioned on Trust 1 and Trust 2 filing any amended
returns and making adjustments that are necessary to properly reflect the treatment of
Trust 1 and Trust 2 as ESBTs 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 10.

        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 and Y are
otherwise eligible to be treated as S corporations or whether Trust 1 or Trust 2 are
eligible to be treated as ESBTs. This ruling is directed only to the taxpayers 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 and Y’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