S corporation receives relief after two trusts missed ESBT elections

Plain-English summary

Two grantor trusts held stock in an S corporation. After their deemed owner
died, each trust remained an eligible S corporation shareholder for two years,
but their trustees failed to elect electing small business trust status when
that period ended. Both trusts then became ineligible shareholders and
terminated the corporation's S election. The corporation continued to file as
an S corporation, represented that the failures were inadvertent and not
tax-motivated, and agreed with its shareholders to any required adjustments.
The IRS granted inadvertent-termination relief under IRC § 1362(f), conditioned
on the trustees filing ESBT elections for both trusts effective on the
termination date within 120 days.

Ruling snapshot

• Question: May the corporation receive § 1362(f) relief after two
  shareholder trusts failed to timely elect ESBT status?
• Outcome: Approved, conditioned on two ESBT elections within 120 days
• Key authorities: IRC §§ 1361(c)(2), 1361(e), and 1362(d), (f); Treas.
  Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202045009 Third Party Communication: None
Release Date: 11/6/2020 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.03-03
Person To Contact:
------------------------------------------ ----------------------------, ID No. --------------
------------------------------------- -----------------
------------------------------ Telephone Number:
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Refer Reply To:
CC:PSI:B03
PLR-128066-19
Date:
August 10, 2020

Legend

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

X = -----------------------------------------------------------------------------
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Trust 1 = -----------------------------------------------------------------------------
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Trust 2 = -----------------------------------------------------------------------------
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State A = -------------

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

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

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

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

Date 5 = -----------------------
PLR-128066-19 2

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

   This letter responds to a letter dated November 12, 2019, submitted on behalf of

X from X’s authorized representatives, requesting inadvertent termination relief pursuant
to § 1362(f) of the Internal Revenue Code (the Code).

                                      FACTS

    According to the information submitted and the representations within, X was

incorporated on Date 1 under the laws of State and elected to be an S corporation
effective Date 2. On Date 2, shares of stock in X were held by Trust 1. Trust 1 was a
grantor trust described in § 1361(c)(2)(A)(i) of which A was a deemed owner.

  On Date 3, Trust 1 transferred shares of X to Trust 2. X represents that Trust 2

was a grantor trust described in § 1361(c)(2)(A)(i) of which A was a deemed owner.

    A died on Date 4. Trust 1 and Trust 2 each qualified under § 1361(c)(2)(A)(ii) as

eligible shareholders for two years from A’s date of death. However, Trust 1 and
Trust 2 each continued to hold the X stock after the two-year period (Date 5). X
represents that Trust 1 and Trust 2 each satisfied the electing small business trust
(ESBT) requirements under § 1361(e). However, the trustees of each of Trust 1 and
Trust 2 failed to make an election under § 1361(e) to treat each of Trust 1 and Trust 2
as ESBTs effective Date 5. Accordingly, Trust 1 and Trust 2 became ineligible
shareholders of X and X’s S corporation election terminated on Date 5.

   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 Trust 1 and Trust 2’s failure to each file an ESBT election and resulting
termination of X’s 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 required as a condition of obtaining relief under § 1382(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 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.
PLR-128066-19 3

   Section 1361(c)(2)(A)(i) provides that, for purposes of § 1361(b)(1)(B), a trust all

of which is treated (under subpart E of part 1 of subchapter J of chapter 1) as owned by
an individual who is a citizen or resident of the United States may be a shareholder of
an S corporation.

   Section 1361(c)(2)(A)(ii) provides that for purposes of § 1361(b)(1)(B), a trust

which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed
owner and which continues in existence after such death may be a shareholder, but
only for the 2-year period beginning on the day of the deemed owner’s death.

 Section 1361(c)(2)(A)(v) provides that for purposes of § 1362(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 section 170(c)(2), (3), (4) or (b) 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)(1)(B) provides that the term ESBT does 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

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)(A) provides that an election under § 1362(a) shall 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.
PLR-128066-19 4

   Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a)

by any corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 the termination, steps were taken so that the corporation is
once more a small business corporation, and (4) the corporation and each person who
was a shareholder of the corporation at any time during the period specified pursuant to
§ 1362(F), agrees to make any adjustments (consistent with the treatment of the
corporation as an S corporation) as may be required by the Secretary with respect to
the period, then, notwithstanding the circumstances resulting in the termination, the
corporation will be treated as continuing to be an S corporation during the period
specified by the Secretary.

                                  CONCLUSION

    Based solely on the facts submitted and representations made, we conclude that

X’s, S corporation election terminated on Date 5, when Trust 1 and Trust 2 became
ineligible shareholders. We further conclude that the termination constituted an
inadvertent termination within the meaning of § 1362(f). Accordingly, pursuant to the
provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date
5 and thereafter, provided that X’s S corporation election was valid and was not
otherwise terminated under § 1362(d).

   This ruling is contingent on the trustees filing an ESBT election for each of

Trust 1 and Trust 2 effective Date 5, with the appropriate service center within 120 days
from the date of this letter. A copy of this letter should be attached to each ESBT
election.

     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 1 and Trust 2’s eligibility to be an ESBT,
respectively.

   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.

  This ruling is directed only to the taxpayer that requested it. According to

§ 6110(k)(3), this ruling may not be used or cited as precedent.
PLR-128066-19 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,



                                  Adrienne M. Mikolashek
                                  Branch Chief, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

Enclosure (2)
Copy of this Letter
Copy for § 6110 purposes

cc: