Late ESBT election received conditional S corporation relief

Plain-English summary

A trust acquired shares of an S corporation but did not timely elect to be treated as an electing small business trust. That failure terminated the corporation's S election, although the corporation and its shareholders continued to treat the corporation as an S corporation. The IRS found the termination inadvertent under IRC § 1362(f) and allowed S corporation treatment to continue. The relief required an adjustment payment and a late ESBT election effective on the share-acquisition date, both within 120 days. The ruling would be null and void if those conditions were not met.

Ruling snapshot

• Question: Could the corporation preserve its S status after a shareholder trust failed to make a timely ESBT election?
• Outcome: Approved with conditions. The taxpayer had 120 days to make the adjustment payment and file the late ESBT election.
• 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: 201908012 Third Party Communication: None
Release Date: 2/22/2019 Date of Communication: Not Applicable
Index Number: 1361.03-03, 1362.02-02,
1362.04-00 Person To Contact:
-------------------, ID No. ------------------
------------------------------------------ Telephone Number:
----------------------------- ----------------------
-------------------------------------------- Refer Reply To:
--------------------------------- CC:PSI:B01
PLR-115747-18
Date:
November 01, 2018

LEGEND

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

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

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

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

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

Years 1 = ---------------

Years 2 = ---------------

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

$a = -------------------------------------------------------------------------

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

This responds to a letter dated February 28, 2018, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code). In additional, X also seeks to
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allow Trust 1 to file a late election to be treated as an electing small business trust
(ESBT) pursuant to section 1361(e) of the Code.

FACTS

According to the information submitted and representations within, X was incorporated
on Date 1, under the laws of State. Effective Date 2, X elected to be taxed as an S
corporation. On Date 3, Trust 1 acquired shares in X. However, a timely election to
treat Trust 1 as an Electing Small Business Trust (ESBT) was not made causing X’s S
corporation election to terminate effective Date 3.

X represents that Trust 1, has at all times met the requirements of an ESBT within the
meaning of section 1361(e), except that the trustees of Trust 1, did not make a timely
ESBT election under section 1361(e)(3). X further represents that Trust 1, has not filed
its income tax return consistent with being ESBT for Years 1.

X represents that, other than the failure to make a valid ESBT election, X has qualified
as a small business corporation at all times since its election on Date 2. X further
represents that X and its shareholders have treated X as an S corporation at all relevant
times. In addition, X 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 further represents that X, its shareholders, and Trust 1 will amend their income tax
returns for Years 2 within 120 days of the date of this ruling letter to reflect treatment of
Trust 1 as an ESBT.

X represents that its S corporation election termination 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 under the inadvertent termination rule 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
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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)(1)(A) 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).

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(d)(2) provides that (A) an election under subsection (a) shall be
terminated whenever (at any time on or after the 1st day of the 1st taxable year for which
the S corporation is an S corporation) such corporation ceases to be a small business
corporation; and (B) any termination under this paragraph shall be 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 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
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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
X’s S election terminated on Date 3 because of the failure to file an ESBT election. We
further conclude that the termination of X’s S election was inadvertent within the
meaning of § 1362(f). Therefore, X will be treated as an S corporation effective Date 2
and thereafter, provided X’s S corporation election is valid and not otherwise terminated
under section 1362(d).

This letter ruling is subject to the following conditions: (1) An adjustment payment in the
amount of $a and a copy of this letter must be sent to the following address: Internal
Revenue Service, Cincinnati Service Center, 201 West Rivercenter Blvd., Covington,
KY 41011, Stop 31, Terri Lackey, Manual Deposit. This payment must be sent no later
than 120 days from the date of this letter; (2) within 120 days from the date of this letter,
an election to treat Trust 1 as an ESBT effective Date 3, must be made with the
appropriate service center. 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, or whether Trust 1, otherwise qualifies as a valid ESBT.

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.
PLR-115747-18 5

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 section 6110 purposes