S corporation status restored after a trustee missed the ESBT election

Plain-English summary

A company had validly elected to be taxed as an S corporation. Later, a trust acquired some of its stock. A trust can hold S corporation stock only if it qualifies as an electing small business trust (ESBT), and that requires the trustee to file a specific ESBT election under Section 1361(e)(3). The trustee never filed it, which automatically terminated the company's S corporation status on the day the trust bought in. The company said the failure was inadvertent and not tax-motivated, and asked the IRS to fix it under Section 1362(f), which lets the IRS forgive an inadvertent termination. The IRS agreed the termination was inadvertent and ruled the company will be treated as continuing to be an S corporation, provided three conditions are met: the trustee files the ESBT election within 120 days, the trust files an amended return reflecting ESBT treatment within 120 days, and a specified payment is sent within 45 days. If the conditions are not met, the ruling is void. The IRS did not opine on whether the company or the trust are otherwise eligible.

Ruling snapshot

• Question: Was the termination of the company's S corporation election (caused by the trustee's failure to make an ESBT election) inadvertent under § 1362(f), so that S status can continue?
• Outcome: Approved (conditioned on curative steps)
• Key authorities: IRC § 1362(f); IRC § 1361(e); IRC § 1362(d)(2); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202044003
Third Party Communication: None
Release Date: 10/30/2020
Date of Communication: Not Applicable
Index Numbers: 1362.00-00, 1362.04-00
Person To Contact:
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CC:PSI:B03
PLR-104933-20
Date:
July 20, 2020

LEGEND

X = -------------------------------------------------------------
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Trust = ------------------------------------------------------------------------------------------------------
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State = -------------

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

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

$n = -- ---------

Year = -------

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

This letter responds to a letter dated January 31, 2020, and subsequent information, submitted on behalf of X by its authorized representative, requesting a ruling under
§ 1362(f) of the Internal Revenue Code (Code).

FACTS

The information submitted states that X, a State corporation, elected to be treated as an S corporation effective Date 1.
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On Date 2, Trust acquired shares of X stock. X represents that Trust qualifies as an electing small business trust (ESBT) within the meaning of § 1361(e). However, the trustee of Trust failed to make an election under § 1361(e)(3) to treat Trust as an ESBT. As a result, X’s S corporation election terminated on Date 2.

X represents that the failure to file an ESBT election and resulting termination of its S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. Further, X and its shareholders agree to make any adjustments consistent with the treatment of X as an S corporation as may be required by the Secretary.

LAW

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 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 one class of stock.

Section 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an ESBT may be an S corporation shareholder.

Section 1361(e)(1)(A) 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)(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, in relevant part, 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 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
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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 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 X’s S corporation election terminated on Date 2 when the trustee of Trust failed to file an ESBT election under § 1361(e)(3). We further conclude that the termination of X’s S corporation election was inadvertent within the meaning of § 1362(f). Therefore, under
§ 1362(f) X will be treated as continuing to be an S corporation on and after Date 2, provided X’s S corporation election was otherwise valid and not otherwise terminated under § 1362(d).

This ruling is contingent on the following conditions: (1) The trustee of Trust must file within 120 days from the date of this letter an ESBT election effective Date 2 with the appropriate service center; (2) Trust must file within 120 days from the date of this letter an amended return for its Year taxable year to properly reflect the treatment of Trust as an ESBT; and (3) As an adjustment under § 1362(f)(4), a payment of $n with 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, Stop 7777, Attn: Manual Deposit, Kansas City, MO 64108.

If the above conditions are not met, then this ruling is null and void. In addition, if these conditions are not met, X must notify the service center with which it filed its S corporation election that its election terminated on Date 2.

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 Trust’s eligibility to be an ESBT.
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This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3) of the Code, 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,

Mary Beth Carchia
Senior Technician Reviewer, Branch 3
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures: Copy of this letter
Copy of this letter for § 6110 purposes

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