Late ESBT election preserved S corporation and QSub status

Plain-English summary

A trust acquired shares of one S corporation but its trustee failed to make a timely electing small business trust election, terminating that corporation’s S status. Later, when the corporation became a qualified subchapter S subsidiary and the trust exchanged its shares for shares of the new parent, the same defect also threatened the parent’s S election. The trust was otherwise eligible as an ESBT, and the trust, corporations, and shareholders consistently filed as though the election were valid. The IRS treated the failures as inadvertent and preserved the original corporation’s S status, the parent’s S status, and the subsidiary’s QSub status. Relief required filing the ESBT election with retroactive effect within 120 days.

Ruling snapshot

• Question: Could a late ESBT election preserve the related corporations’ S election and QSub treatment?
• Outcome: approved; continuous S and QSub status was granted subject to filing the ESBT election within 120 days
• Key authorities: IRC §§ 1361(c), 1361(e), 1362(d), 1362(f); Treas. Reg. §§ 1.1361-1(m), 1.1361-3

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201919001                                            Third Party Communication: None
Release Date: 5/10/2019                                      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-118698-18
                                                             Date:
                                                             November 29, 2018

LEGEND

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

Y        =         ---------------------------------------
--------------------------------------------

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

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

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

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

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

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

Date 6=           --------------------

State =           ---------



Dear -----------:
PLR-118698-18                                2

This responds to a letter dated June 4, 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, Y was formed on
Date 1 and made a timely S corporation election effective Date 2. X was formed on
Date 5 and made a timely S corporation election effective Date 4, under the laws of
State. On Date 6, Y became a wholly-owned subsidiary of X and X filed a timely
Qualified Subchapter S Subsidiary election for Y effective Date 6.

X represents that on Date 3, Trust acquired shares in Y. The trustee of Trust failed to
make a timely Electing Small Business Trust (ESBT) election, thus causing Y’s S
corporation election to terminate effective Date 3. On Date 6, Trust acquired shares in
X when its shares in Y were exchanged for shares in X, thus causing X’s S corporation
election to terminated effective Date 6.

X represents that Trust was eligible to make an Electing Small Business Trust (ESBT)
election as of Date 3, however, the trustee of Trust inadvertently failed to file an ESBT
election. X represents that Trust has been treated as if a valid ESBT election was made
on Date 3 and has at all times since Date 3 met the requirements of an ESBT under §
1361(d)(3). X further represents that Trust has filed returns consistent with it being an
ESBT.

X represents that the circumstances resulting in the termination of X’s S corporation
election and the failure to make a timely ESBT election was 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 an ESBT election for Trust on Date 3, X has qualified as a small business
corporation at all times since its election on Date 6. 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.
PLR-118698-18                                 3

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 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 1362(a)(2) provides that an election under § 1362(a) shall be valid only if all
persons who are shareholders in such corporation on the day on which such election is
made consent to such election.

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 1361(b)(3)(A) generally provides that a QSub shall not be treated as a
PLR-118698-18                                4

separate corporation and all assets, liabilities, and items of income, deduction, and
credit of a QSub shall be treated as assets, liabilities, and such items (as the case may
be) of the S corporation.

Section 1361(b)(3)(B) defines a QSub as a domestic corporation which is not an
ineligible corporation, if 100 percent of the stock of the corporation is owned by the S
corporation, and the S corporation elects to treat the corporation as a Qualified
subchapter S subsidiary.

Section 1.1361-3(a) prescribes the time and manner for making an election to be
classified as a QSub.

Section 1.1361-3(a)(4) provides that an election may be effective up to two months and
15 days prior to the date the election is filed or not more than 12 months after the
election is filed. The proper form for making the election is Form 8869, Qualified
subchapter S subsidiary Election.

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 to file an ESBT election effective Date 3 caused an inadvertent
termination of Y’s S corporation election within the meaning of § 1362(f) on Date 3.
Pursuant to the provisions of § 1362(f), Y will be treated as continuing to be an S
corporation beginning on and after Date 2, X will be treated as continuing to be an S
PLR-118698-18                                  5

corporation beginning on and after Date 4, and Y will continue to be a treated as a
QSub of X effective Date 6, 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 as an ESBT effective Date 3, 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 was otherwise eligible to be an 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.

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


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