Four missed ESBT elections receive conditional S corporation relief

Plain-English summary

Four shareholders transferred S corporation stock to four trusts intended to be electing small business trusts, but the trustees did not timely file the ESBT elections. The missed elections caused the corporation's S election to terminate when the trusts became shareholders. The corporation continued filing as an S corporation and represented that the failures were inadvertent and not motivated by tax avoidance. The IRS granted relief under section 1362(f), subject to a specified payment, amended or newly filed returns, and retroactive ESBT elections. The required actions had to be completed within 45 or 120 days, depending on the condition, or the ruling would be void.

Ruling snapshot

• Question: May the corporation retain S status after four shareholder trusts failed to timely elect ESBT treatment?
• Outcome: approved
• Key authorities: IRC §§ 1361(c), 1361(e), 1362(d), 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: 202009011                                              Third Party Communication: None
Release Date: 2/28/2020                                        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-109178-19
                                                               Date:
                                                               October 18, 2019




LEGEND

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

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

B                 =         --------------------------
-----------------------------------------------------

C                 =        -----------------------

D                 =        ------------------------------

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

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

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

Trust 4           =         ------------------------------------
----------------------------------------------------

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

Date 2            =        ----------------------
PLR-109178-19                                         2

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

Years           =     -----------------------------

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

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


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

This responds to a letter dated April 15, 2019, 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.

On Date 3, A, B, C and D transferred shares in X to Trust 1, Trust 2, Trust 3 and Trust

4. Trust 1, Trust 2, Trust 3 and Trust 4 were intended to be treated as Electing Small
Business Trusts (ESBTs) as of Date 3. However, the trustees of Trust 1, Trust 2, Trust
3 and Trust 4 inadvertently failed to file ESBT elections, causing X’s S corporation
election to terminate effective Date 3.

X represents that Trust 1, Trust 2, Trust 3 and Trust 4 have not been treated at all times
since Date 3 as if valid ESBT elections were made as of Date 3, but have at all times
since Date 3 met the requirements of an ESBT under § 1361(d)(3) of the Code. 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 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 ESBT elections for Trust 1, Trust 2, Trust 3
and Trust 4 on Date 3, 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
PLR-109178-19                                 3

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 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 1 class of stock.

Section 1361(c)(2)(A)(i) 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) defines an ESBT as 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 taxable years of such 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 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
Qualified Subchapter S Trust election (generally within the 16-day-and-2-month period
beginning on the day that the stock is transferred to the trust).

Section 1362(a) provides that a small business corporation may elect to be an S
corporation.

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
PLR-109178-19                                 4

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) or § 1361(b)(3)(C); (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 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 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, Trust 3 and Trust 4 to file ESBT elections effective Date 3
caused an inadvertent termination of X’s S corporation election within the meaning of
§ 1362(f) on Date 3. Pursuant to the provisions of § 1362(f), X will be treated as
continuing to be an S corporation beginning on and after Date 3, unless X's S
corporation election is otherwise terminated under § 1362(d).

This letter ruling is subject to the following conditions: (1) As an adjustment under
§ 1362(f)(4), a payment of $a and a copy of this letter must be sent to the following
address within 45 days from the date of this letter: Internal Revenue Service, Kansas
City Submission Processing Campus, 333 W. Pershing Road, Kansas City, MO 64108,
Stop 7777, Attn.: Manual Deposit; (2) Within 120 days from the date of this letter, X and
its shareholders must amend or file all relevant tax returns for Years consistent with the
relief granted in this letter; and (3) Within 120 days from the date of this letter, the
trustees of Trust 1, Trust 2, Trust 3 and Trust 4 must file elections to treat Trust 1, Trust
2, Trust 3 and Trust 4 as ESBTs effective Date 3 with the appropriate service center. A
copy of this letter should be attached to the ESBT elections. If these conditions are not
met, then this 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 or whether Trust 1, Trust 2, Trust 3 and Trust 4 were or are otherwise
eligible to be ESBTs.
PLR-109178-19                                5

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.

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.

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



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