S corporation status restored after a shareholder trust missed its ESBT election following the owner's death

Plain-English summary

An S corporation had a shareholder that was a grantor trust, which is a
permitted S corporation shareholder while the grantor is alive. When the
grantor (the deemed owner) died, the trust stayed eligible for only two more
years, after which it needed to become an Electing Small Business Trust
(ESBT) to keep holding the stock. The trust met every requirement of an
ESBT except that its trustee never filed the ESBT election, so when the
two-year window closed the corporation's S election automatically
terminated. The company asked the IRS for relief under Section 1362(f),
which lets the IRS forgive an inadvertent termination. The IRS agreed the
termination was inadvertent and ruled the company continues to be an S
corporation, on the conditions that a late ESBT election is filed within
120 days and the affected returns are amended to treat the trust as an ESBT.
Small businesses that use trusts as owners care because a missed election
like this can otherwise silently blow up pass-through tax treatment for
everyone involved.

Ruling snapshot

• Question: Was the S election's termination (from a missed ESBT election after the owner's death) inadvertent and curable under § 1362(f)?
• Outcome: Approved (inadvertent termination relief; S status continues, subject to a late ESBT election and amended returns)
• Key authorities: IRC § 1362(f); IRC § 1361(c)(2), (d)(3), (e)(3); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201918001 Third Party Communication: None
Release Date: 5/3/2019 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-113551-18
Date:
November 26, 2018

LEGEND

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

A ----------

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

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

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

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

Date 4 = ----------

Date 5 = ----------

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

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

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

This responds to a letter dated January 24, 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.
PLR-113551-18 2

                                      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, A, a shareholder of X, transferred X stock to Trust. Trust was a
grantor trust described in § 1361(c)(2)(A)(i) of which A was the deemed owner. On Date
4, A died and Trust ceased to be a grantor trust, but continued to qualify as an eligible S
corporation shareholder under § 1361(c)(2)(A)(ii) for the 2-year period beginning on the
day of the deemed owner's death. However, Trust continued to hold the X stock after
the 2-year period had ended on Date 5. According to X, Trust qualifies as an Electing
Small Business Trust (ESBT), but its beneficiary made no ESBT election. As a result,
X's S corporation election terminated on Date 5.

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

X represents that, other than the failure to make a valid ESBT election by Date 5, 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 the beneficiaries of Trust, will amend
their income tax returns for all open tax years within 120 days of the date of this ruling
letter to reflect treatment of Trust as an ESBT.

X represents that its S corporation election termination was inadvertent and was not
motivated by tax avoidance or retroactive tax planning.

                              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.

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.
PLR-113551-18 3

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 I of subchapter J of chapter 1) as owned by an
individual who is a citizen or resident of the United States may be a shareholder of an S
corporation. Section 1361(c)(2)(B)(i) provides that for purposes of § 1361(b)(1), in the
case of a trust described in § 1361(c)(2)(A)(i), the deemed owner shall be treated as the
shareholder.

Section 1361(c)(2)(A)(ii) provides that a trust which was described in § 1361(c)(2)(A)(i)
immediately before the death of the deemed owner and which continues in existence
after such death, is a permitted shareholder, but only for the 2-year period beginning on
the day of the deemed owner's death.

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 ESBT does 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 an S corporation election will be terminated whenever
(at any time on or after the first day of the first taxable year for which the corporation is
PLR-113551-18 4

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 (A) 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 to obtain shareholder consents, or (B) was terminated under § 1362(d)(2)
or (3) or § 1361(b)(3)(C); (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 election was made
or 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 upon the facts submitted and the representations made, we conclude that
the termination of X's S corporation election on Date 5 was inadvertent within the
meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X will
be treated as continuing to be an S corporation from Date 5 and thereafter, provided X's
S corporation election was valid and was not otherwise terminated under § 1362(d).

This letter ruling is subject to the following conditions: (1) Within 120 days from the date
of this letter, an election to treat Trust as an ESBT effective Date 5 must be made with
the appropriate service center; and (2) X’s shareholders, and the beneficiaries of Trust,
must amend their income tax returns for all open tax years within 120 days of the date
of this ruling letter to reflect the treatment of Trust as an ESBT. A copy of this letter
should be attached to the ESBT election. If these conditions are not met, then this letter
ruling is null and void. Furthermore, if these conditions are 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.

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-113551-18 5

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to your authorized representatives.

                                  Sincerely,


                                  Joy C. Spies
                                  Joy C. Spies
                                  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