Late ESBT election receives inadvertent S corporation termination relief

Plain-English summary

A trust acquired shares of an S corporation but its trustee did not timely elect electing small business trust status. Without that election the trust was an ineligible shareholder, terminating the corporation's S election. The trust otherwise met the ESBT requirements, the corporation continued filing consistently with S status, and the parties represented that the lapse was inadvertent and not motivated by tax avoidance or retroactive planning. The IRS granted section 1362(f) relief, treating the corporation as continuously maintaining S status, conditioned on the trustee filing an ESBT election effective on the original acquisition date within 120 days.

Ruling snapshot

• Question: Was the S election termination caused by the trustee's failure to timely make an ESBT election inadvertent?
• Outcome: approved (continuous S status was restored, conditioned on an ESBT election within 120 days)
• Key authorities: IRC §§ 1361(c), 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: 202021006                                               Third Party Communication: None
 Release Date: 5/22/2020                                         Date of Communication: Not Applicable
 Index Number: 1361.00-00, 1361.03-00,
               1361.03-03, 1362.00-00,                           Person To Contact:
               1362.02-00, 1362.02-02,                           ----------------, ID No. ---------------
               1362.04-00                                        Telephone Number:
                                                                 --------------------
 -------------------------------------------                     Refer Reply To:
 ---------------------------------------                         CC:PSI:01
 ------------------------------                                  PLR-119416-19
 --------------------------                                      Date:
 ---------------------------                                     February 06, 2020




Legend

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

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

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

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

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

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



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

This responds to a letter dated August 20, 2019, requesting relief under section 1362(f)
of the Internal Revenue Code (the Code).

                                                         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.
PLR-119416-19                                  2

On Date 3, Trust acquired shares in X. However, a timely election to treat Trust as an
Electing Small Business Trust (ESBT) was not made, causing X’s S corporation
election to terminate effective Date 3.

X represents that Trust has at all times met the requirements of an ESBT within the
meaning of section 1361(e), except that the trustee of Trust did not make a timely ESBT
election under section 1361(e)(3).

X represents that upon discovering that its S election had terminated, X took corrective
action by filing this request for relief. X represents that the circumstances resulting in the
inadvertent termination and the failure to make a timely ESBT election 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 make a valid ESBT election 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) 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.

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 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 chapter 1) 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) 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
PLR-119416-19                                 3

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 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(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
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 terminated under § 1362(d)(2); (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 to make an ESBT election effective Date 3 caused an inadvertent
termination of X’s S corporation election within the meaning of § 1362(f). Pursuant to
the provisions of § 1362(f), X will be treated as continuing to be an S corporation
PLR-119416-19                                   4

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 condition that within 120 days from the date of this
letter, an election to treat Trust as an ESBT effective Date 3 must be made with the
appropriate service center. A copy of this letter 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 or is 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 X’s authorized representative.


                                         Sincerely,


                                         Joy Spies
                                         Joy Spies
                                         Senior Technician Reviewer, Branch 1
                                         Office of the Associate Chief Counsel
                                         (Passthroughs and Special Industries)

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


cc: