S-corporation status preserved after trusts missed their ESBT elections

Plain-English summary

An S corporation can only have certain kinds of shareholders. When a trust becomes a shareholder, it usually must file an "electing small business trust" (ESBT) election to remain a permitted owner; if it does not, the company can lose its S-corporation status. Here three trusts acquired shares in an S corporation but their trustees inadvertently failed to file the ESBT elections on time, which technically terminated the company's S election. The company asked the IRS for relief under Internal Revenue Code § 1362(f), which lets the IRS treat such a termination as if it never happened when the failure was inadvertent, the taxpayer promptly fixes it, and everyone agrees to any needed adjustments. The IRS found the termination inadvertent and ruled the company will be treated as continuing to be an S corporation, on the condition that the three trusts file their ESBT elections within 120 days. This is common cleanup relief that protects the pass-through tax treatment the business and its owners have been relying on. The IRS expressed no opinion on whether the company is otherwise eligible to be an S corporation or whether the trusts otherwise qualify as ESBTs.

Ruling snapshot

• Question: Was the termination of the company's S election (caused by trusts missing their ESBT elections) inadvertent, so that § 1362(f) relief applies?
• Outcome: Approved (S status treated as continuing, contingent on filing the ESBT elections within 120 days)
• Key authorities: IRC §§ 1362(f), 1362(d)(2), 1361(b), 1361(e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                     Department of the Treasury
                                             Washington, DC 20224

Number: 201845008                     Third Party Communication: None
Release Date: 11/9/2018               Date of Communication: Not Applicable
Index Number: 1361.03-03, 1362.02-02
                                      Person To Contact:
--------------------------            --------------, ID No. -----------------
---------------------------------     Telephone Number:
-----------------                     -------------------
-------------------------------       Refer Reply To:
                                      CC:PSI:B01
                                      PLR-103883-18
                                      Date:
                                      July 24, 2018




LEGEND

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

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

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

Trust 3 =          --------------------------------
-------------------------------------------

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

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

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



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

This responds to a letter dated February 8, 2018, and supplemental correspondence,
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 formed and
made a timely S corporation election effective Date 1, under the laws of State.

X represents that on Date 2, Trust 1, Trust 2, and Trust 3 acquired shares in X. The
trustees of Trust 1, Trust 2, and Trust 3 failed to make a timely Electing Small Business
Trust (ESBT) elections, thus causing X's S corporation to terminate.

X represents that Trust 1, Trust 2, and Trust 3 were eligible to make an Electing Small
Business Trust (ESBT) elections as of Date 2, however, the trustees of Trust 1, Trust 2,
and Trust 3 inadvertently failed to file ESBT elections. X represents that Trust 1, Trust
2, and Trust 3 have been treated as if valid ESBT elections were made on Date 2 and
have at all times since Date 2 met the requirements of an ESBT under § 1361(d)(3). X
further represents that Trust 1, Trust 2, and Trust 3 reported their allocable shares of
Trust 1, Trust 2, and Trust 3 income on all affected returns consistent with being an
ESBT.

X represents that the circumstances resulting in the termination of X's S corporation
election and the failure to make timely ESBT elections were inadvertent and not
motivated by tax avoidance or retroactive tax planning. X further represents that X has
filed its income tax returns consistent with having a valid S election in effect for all
taxable years since X elected to be an S corporation. X represents that other than the
failure to file ESBT elections for Trust 1, Trust 2, and Trust 3 on Date 2, X has qualified
as a small business corporation at all times since its election on Date 1. Lastly, X and
its shareholders agree to make any adjustments required as a condition of obtaining
relief under § 1362(f) that may be required by the Secretary.

LAW AND ANALYSIS

Section 1361(a) provides that an S corporation is a small business corporation for which
an election under § 1362(a) is in effect.

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 the year.

Section 1361(b)(1) provides that the terms "small business corporation" means 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(e) 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(c)(2)(A)(i) of the Code provides that for purposes of section 1361(b)(1) a
trust all of which is treated (under subpart E of part I of subchapter J of this chapter) 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)(v) provides that for purposes of § 1361(b)(1)(B), an ESBT is a
permissible shareholder.

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).

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(a) provides that a small business corporation may elect to be an S
corporation.

Section 1362(d)(2)(A) 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, 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); (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 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 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
the failure of Trust 1, Trust 2, and Trust 3 to file ESBT elections effective Date 2 caused
an inadvertent termination of X's S corporation election within the meaning of
§ 1362(f) on Date 2. Pursuant to the provisions of § 1362(f), X will be treated as
continuing to be an S corporation beginning on and after Date 2, unless X's S
corporation election is otherwise terminated under § 1362(d).

This letter ruling is subject to the condition that within 120 days from the date of this
letter, an election to treat Trust 1, Trust 2, and Trust 3 as ESBTs effective Date 2, must
be filed with the appropriate service center. A copy of this letter ruling should be
attached to the ESBT election. If this condition is not met, then this ruling is null and
void. Furthermore, if this condition is not met, X must send notification that its S
election has terminated to the service center with which X's S election was filed.

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 or whether Trust 1, Trust 2, and Trust 3 were or are otherwise eligible to be
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 representatives.

                                      Sincerely,

                                      David R. Haglund

                                      David R. Haglund
                                      Branch Chief, Branch 1
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)



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


cc: