IRS treats an S corporation's election termination as inadvertent after a trust missed its ESBT election, and restores S status

Plain-English summary

An S corporation is a small business corporation that is taxed by passing income
through to its owners, but it can only have certain kinds of shareholders. When a
trust buys S corporation stock, the trust usually has to file an election to be
an "electing small business trust" (ESBT) to be a permitted shareholder. Here, a
trust bought the company's stock and qualified as an ESBT, but the trustee never
filed the ESBT election, so the company technically stopped being a valid S
corporation on that date. The company asked the IRS for relief under Code Section
1362(f), which lets the IRS forgive a termination that was inadvertent. Finding
that the termination was not driven by tax avoidance and that the company and its
shareholders had kept treating it as an S corporation, the IRS ruled the
termination inadvertent and treated the company as continuing to be an S
corporation, on the condition that the trustee files the missing ESBT election
within 120 days and everyone files consistent returns.

Ruling snapshot

• Question: Was the termination of the company's S corporation election (caused by a trust's missed ESBT election) inadvertent under § 1362(f), so S status can be restored?
• Outcome: Approved (inadvertent termination relief granted, subject to conditions)
• Key authorities: IRC § 1362(f); IRC § 1362(d)(2); IRC § 1361(b), (c)(2), (e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201846002
Release Date: 11/16/2018
Index Number: 1362.04-00

Third Party Communication: None
Date of Communication: Not Applicable

Person To Contact:
-----------------------, ID No. -------------------
Telephone Number:

Refer Reply To:
CC:PSI:03
PLR-107061-18
Date: August 20, 2018

LEGEND

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

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

D1 = ------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
D2 = -----------------

D3 = --------------------------

Trust = ------------------------------------------------------------------------------------------------------
--------------------------

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

  This letter responds to a letter dated February 28, 2018, and additional

information, submitted on behalf of X by its authorized representative requesting a ruling
under § 1362(f) of the Internal Revenue Code.

                                               FACTS

    X was formed under the laws of State on D1 and elected to be an S corporation

effective D2. On D3, Trust purchased X stock. X represents that Trust was eligible to

PLR-107061-18 2

be an electing small business trust (ESBT) within the meaning of § 1361(e) on D3, but
the trustee did not timely file an ESBT election. Therefore, because Trust was not a
permitted shareholder, X's S corporation election terminated on D3.

   X represents that the termination of its S corporation election was not motivated

by tax avoidance or retroactive tax planning. X further represents that X and its
shareholders have filed consistently with the treatment of X as an S corporation since
D2. X and its shareholders have agreed to make any adjustments that the
Commissioner may require, consistent with the treatment of X as an S corporation.

                               LAW AND ANALYSIS

  Section 1362(a)(1) provides that, except as provided in § 1362(g), a small

business corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

    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) provides that the term "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 one class of stock.

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

may be a shareholder.

    Section 1361(e)(1)(A) provides that, except as provided in § 1361(e)(1)(B), 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)(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 be made by

the trustee. Any such election shall apply to the taxable year of the trust for which made
and all subsequent years of the trust unless revoked with the consent of the Secretary.

   Section 1.1361-1(m)(2)(i) of the Income Tax Regulations provides that the

trustee of an ESBT must make the ESBT election by signing and filing, with the service

PLR-107061-18 3

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)(A) provides that an election under § 1362(a) will be

terminated whenever (at any time on or after the first day of the first taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation. Section 1362(d)(2)(B) provides that any termination under
§ 1362(d) is effective on and after the date of cessation.

    Section 1362(f) provides, in relevant part, 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 the termination were inadvertent, (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
the 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 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 termination, the corporation will 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 corporation election terminated on D3. We also conclude that the
circumstances resulting in the termination were inadvertent within the meaning of
§ 1362(f). Accordingly, under § 1362(f), X will be treated as an S corporation from D3
and thereafter, provided X's S corporation election was otherwise valid and has not
otherwise terminated under § 1362(d).

    This ruling is conditioned on the trustee of Trust filing an ESBT election effective

D2, with the appropriate service center within 120 days of the date of this letter. A copy
of this letter should be attached to the ESBT election. X and its shareholders must file
any original and amended returns for all open years consistent with the relief granted in
this letter. If these conditions are not met, then this ruling is null and void.

   Except as specifically ruled above, we express no opinion concerning the federal

tax consequences of the facts described above under any other provisions of the Code.
Specifically, we express no opinion regarding X's eligibility to be an S corporation, or
Trust's eligibility to be an ESBT.

  This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

provides that it may not be used or cited as precedent.

PLR-107061-18 4

   The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.

                                 Sincerely,

                                 /s/
                                 Caroline E. Hay
                                 Assistant to the Branch Chief, Branch 3
                                 Office of the Associate Chief Counsel
                                 (Passthroughs & Special Industries)

Enclosures (2):

  Copy of this letter
  Copy for § 6110 purposes