S corporation receives inadvertent termination relief for missed ESBT elections

Plain-English summary

Two trusts were eligible S corporation shareholders until a redacted date, when they needed electing small business trust elections to remain eligible. Their trustees did not timely make those elections, which caused the corporation's S election to terminate. The corporation and its shareholders nevertheless continued to treat the company as an S corporation and represented that the termination was inadvertent rather than tax-motivated. The IRS granted relief under section 1362(f) and treated the company as continuing to be an S corporation from the termination date. The relief required both trusts to make ESBT elections effective on that date and required the company and shareholders to file all necessary original or amended returns for open years within 120 days, subject to earlier limitations deadlines. Failure to meet those conditions would make the ruling void.

Ruling snapshot

• Question: May the corporation keep its S status after two shareholder trusts failed to make timely ESBT elections?
• Outcome: approved (the termination was treated as inadvertent, subject to elections and corrective returns)
• Key authorities: IRC §§ 1361 and 1362(d) and (f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202019014 Third Party Communication: None
Release Date: 5/8/2020 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
---------------------------------------- -------------------, ID No. -----------------
---------------------------------------------- Telephone Number:
---------------------------------------- --------------------
------------------------ Refer Reply To:
CC:PSI:01
PLR-117471-19
Date:
January 15, 2020

LEGEND

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

              -----------------------

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

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

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

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

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

State = --------

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

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

This responds to a letter dated July 22, 2019, and supplemental information, submitted
on behalf of X by X's authorized representatives, requesting relief under section 1362(f)
of the Internal Revenue Code (the Code).

                                               FACTS

PLR-117471-19 2

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. Trust 1 and Trust 2 were permitted S corporation shareholders under
§ 1361(c)(2)(A)(i) until Date 3. However, an Electing Small Business Trust (ESBT)
election effective Date 3 was not timely filed for Trust 1 and Trust 2. Accordingly, Trust 1
and Trust 2 became ineligible shareholders of X and X's S corporation election
terminated on Date 3.

X represents that Trust 1 and Trust 2 have at all times met the requirements of an ESBT
within the meaning of § 1361(d)(3), except that the trustees of Trust 1 and Trust 2 did
not make timely ESBT elections under § 1361(e)(3). X further represents that Trust 1
and Trust 2 have not filed their income tax returns consistent with being ESBTs for
Years.

X represents that, other than the failure to make valid ESBT elections by Date 3, 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 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) 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
class of stock.

Section 1361(c)(2)(A)(i) provides that, for purposes of § 1362(b)(1)(B), a trust all of
which is treated as owned by an individual who is a citizen or resident of the United
States may be an S corporation shareholder.

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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 “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 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
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) or
was terminated under § 1362(d)(2) or (3); (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 election was made or termination occurred is a small business corporation; and (4)
the corporation for which the election was made or 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

PLR-117471-19 4

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 was inadvertently terminated within the meaning of § 1362(f) on Date 3
because Trust 1 and Trust 2 became ineligible shareholders of X. Therefore, X will be
treated as an S corporation effective Date 3 and thereafter, provided X’s S corporation
election is otherwise valid and not otherwise terminated under § 1362(d).

This letter is subject to the following conditions that must occur within 120 days from the
date of this letter (1) an election to treat Trust 1 and Trust 2 as ESBTs effective Date 3
must be made with the appropriate service center and (2) X and its shareholders must
file any necessary original and amended returns for all open years, including Years,
consistent with the relief granted in this letter reflecting the treatment of Trust 1 and
Trust 2 as ESBTs. If the statute of limitations for any of Years closes prior to 120 days
from the date of this letter, condition (2) must be satisfied for that year prior to the date
the statute of limitations closes for that year.
A copy of this letter should be attached to the ESBT elections and any amended
returns. 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.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and is accompanied by a penalty of perjury statement
executed by the 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.

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-117471-19 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,

                                            David R. Haglund
                                            David R. Haglund
                                            Branch Chief, Branch 1
                                            Office of the Associate Chief Counsel
                                            (Passthroughs and Special Industries)

Enclosures (2)
Copy of letter
Copy of letter for §6110 purposes

cc: