S corporation receives relief for three missed ESBT elections

Plain-English summary

After an eligible shareholder died, her S corporation shares passed under her will to three trusts. Those trusts were permitted S corporation shareholders for two years, but their trustees failed to make electing small business trust elections when that period ended. The missed elections caused the corporation's S election to terminate. The corporation represented that the failure was inadvertent, was not motivated by tax avoidance or retroactive planning, and was its only qualification problem. The IRS treated the corporation as continuously maintaining S status, conditioned on the trusts filing retroactive ESBT elections within 120 days and the corporation and shareholders filing required original or amended returns within the same period. The ruling did not decide whether the corporation or trusts otherwise met the substantive eligibility rules.

Ruling snapshot

• Question: Could the corporation retain continuous S status after three trusts missed their ESBT elections?
• Outcome: Approved as an inadvertent termination, subject to elections and returns filed within 120 days.
• Key authorities: IRC §§ 1361(c)(2), 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: 201922021                                              Third Party Communication: None
Release Date: 5/31/2019                                        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-118898-18
                                                               Date:
                                                               December 6, 2018




LEGEND

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

A        =        ----------------------------

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

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

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

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

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

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

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

Date 5=           --------------------------
PLR-118898-18                                2


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



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

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, X was formed on
Date 1 and made a timely S corporation election effective Date 2, under the laws of
State.

Prior to her death, A, an eligible shareholder, owned shares in X. On Date 3, A died.
Pursuant to A’s Will, on Date 4, A’s shares were transferred to Trust 1, Trust 2 and
Trust 3. Trust 1,Trust 2 and Trust 3 were eligible shareholders of X from Date 4 to Date
5 under § 1361(c)(2)(A)(iii).

X represents that Trust 1, Trust 2, and Trust 3 were eligible to make an Electing Small
Business Trust (ESBT) elections as of Date 5, however, the trustees of Trust 1, Trust 2,
and Trust 3 failed to file ESBT elections. As a result, X’s S corporation election
terminated as of Date 5.

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 represents that other than the
failure to file ESBT elections for Trust 1, Trust 2, and Trust 3 on Date 5, X has qualified
as a small business corporation at all times since its election on Date 2. 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)(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,
PLR-118898-18                                 3

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(c)(2)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust with
respect to stock transferred to it pursuant to the terms of a will is a permitted
shareholder, but only for the 2-year period beginning on the day on which such stock is
transferred to it.

Section 1361(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B), an ESBT is a
permissible shareholder.

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)(2), (3), (4), or (5), or 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 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 a trust 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)(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)(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 terminated under § 1362(d)(2) or (3); (2) the Secretary determines that
the circumstances resulting in such 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
PLR-118898-18                                4

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 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 5 caused
an inadvertent termination of X’s S corporation election within the meaning of
§ 1362(f) on Date 5. Pursuant to the provisions of § 1362(f), X will be treated as
continuing to be an S corporation beginning on and after Date 5, unless X's S
corporation election is otherwise terminated under § 1362(d).

This letter ruling is contingent upon the filing of ESBT elections within 120 days from the
date of this letter effective Date 5 for Trust 1, Trust 2, and Trust 3 with the appropriate
service center. A copy of this letter should be attached to the ESBT elections. This
letter ruling is also contingent upon X and its shareholders filing, within 120 days from
the date of this letter, original and amended returns for all open years consistent with
the relief in this letter.

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.
PLR-118898-18                                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,


                                      Faith P. Colson
                                      Faith P. Colson
                                      Senior Counsel, 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