Corporation receives S status relief after four trusts missed ESBT elections

Plain-English summary

A parent S corporation created a wholly owned subsidiary and elected qualified
subchapter S subsidiary status for it. Four trusts later acquired parent stock
but did not timely make electing small business trust elections, causing the S
election to terminate when the first trust became an ineligible shareholder.
The parent later merged into the subsidiary in a transaction represented to be
an F reorganization, with the subsidiary surviving. The corporation, its
shareholders, and the trusts had consistently filed as though S and ESBT status
continued, and represented that the failures were inadvertent and not
tax-motivated. The IRS granted relief under § 1362(f), preserved S status from
the first termination date, and held the QSub election valid through the
merger. Relief is conditioned on all four trustees filing retroactive ESBT
elections within 120 days.

Ruling snapshot

• Question: May S corporation and QSub status continue despite four
  shareholder trusts' failures to timely elect ESBT status?
• Outcome: Approved, conditioned on four ESBT elections within 120 days
• Key authorities: IRC §§ 1361(b), 1361(e), 1362(d), 1362(f), and
  368(a)(1)(F); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202046005 Third Party Communication: None
Release Date: 11/13/2020 Date of Communication: Not Applicable
Index Number: 1361.05-00, 1362.00-00,
1362.04-00, 9100.31-00 Person To Contact:
------------------------, ID No. -----------------
------------------------------------ Telephone Number:
--------------------------------- --------------------
------------------------------ Refer Reply To:
----------------------------------------- CC:PSI:B03
PLR-104972-20
------------------------------- Date:
-------------------------------- August 17, 2020
---------------------------------

LEGEND

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

Y = ------------------------------------------------------------------------------------------

Z = ------------------------------------

Trust1 = -----------------------------------------------------------------------------
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Trust2 = --------------------------------------------------------------------------

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Trust3 = -----------------------------------------------------------------------------------------

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Trust4 = --------------------------------------------------------------------
PLR-104972-20 2

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State = --------

Date1 = -------------------------

Date2 = ---------------------

Date3 = -------------------------

Date4 = -------------------

Date5 = -------------------

Date6 = ----------------

Date7 = -------------------

Date8 = ------------------

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

   This responds to a letter dated January 16, 2020, submitted on behalf of X by X’s

authorized representative, requesting a ruling under §1362(f) of the Internal Revenue
Code (the Code).

                                                   FACTS

   The information submitted states that Y was incorporated under the laws of State

on Date1. Y elected to be taxed as an S corporation effective on Date2. X was formed
by Y as its wholly-owned subsidiary under the laws of State on Date3. Y made an
election under § 1361(b)(3)(B)(ii) to treat X as a Qualified Subchapter S Subsidiary
(“QSub”) effective on Date3. On Date4, Trust1 acquired shares of Y. On Date5, Trust2
and Trust3 acquired shares in Y. On Date6, Trust4 acquired shares in Y.

   On Date7, incident to what X represents was part of a reorganization under

§ 368(a)(1)(F), Y merged with X and the Y shares were replaced with X shares, and X
was treated as the surviving corporation. On Date8, X entered into an agreement to be
acquired by Z.
PLR-104972-20 3

   X represents that timely and proper Electing Small Business Trust (ESBT)

elections under § 1361(e) were never made on behalf of Trust1, Trust2, Trust3 and
Trust4 (the “trusts”).

    X represents that the trusts meet the requirements of § 1361(e)(1)(A) to be

ESBTs, except that ESBT elections were not timely made on behalf of each of the trusts
at the time the stock was transferred to the trusts, respectively. Accordingly, the S
corporation election of X terminated on Date4, the date that stock was first acquired by
Trust1, because Trust1 was an ineligible S corporation shareholder at the time of that
transfer. In addition, the S corporation election of X would have terminated on
subsequent dates as a result of the transfers of stock to Trust2, Trust3, and Trust4, if
the election had not already terminated on Date4.

   X represents that X and all of its shareholders have always filed tax returns

consistent with X being an S corporation. In addition, X represents that each of the
trusts have filed tax returns consistent with their treatment as ESBTs. X further
represents that the circumstances resulting in the termination of X’s S corporation
election were inadvertent and were not motivated by tax avoidance or retroactive tax
planning. X and its shareholders have agreed to make adjustments consistent with the
treatment of X as an S corporation, and the trusts as ESBTs, as 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 1
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.
PLR-104972-20 4

   Section 1361(e)(1)(B) provides that an 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) 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
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 (A) an election under subsection (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; and (B) any termination under this paragraph shall be effective on
and after the date of cessation.

   Section 1362(f) provides that if (1) an election under § 1362(a) by a corporation

(A) 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 to obtain
shareholder consents or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary
determines that the circumstances resulting in the ineffectiveness or termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in the ineffectiveness or termination, steps were taken (A) so
that the corporation is a small business corporation or (B) to acquire the shareholder
consents, 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 such adjustments (consistent with the treatment of the corporation as an S
corporation) as may be required by the Secretary with respect to such period, then,
notwithstanding the circumstances resulting in the ineffectiveness or termination, the
corporation will be treated as an S corporation during the period specified by the
Secretary.

                                  CONCLUSION

PLR-104972-20 5

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

that X’s S corporation election terminated on Date4 as the result of the failure of the
trustee of Trust1 to make an election under § 1361(e)(3) to treat Trust1 as an ESBT
effective as of the date of the transfer of Y stock to Trust1. In addition, Y’s S
corporation election would have terminated on Date6 when Y stock was transferred to
Trust2 and Trust3, or on Date7 when Y stock was transferred to Trust4, as a result of
the failure of the trustees of Trust2, Trust3 and Trust4 to make timely and proper ESBT
elections under § 1361(e)(3) on behalf of those trusts, if Y’s S corporation election had
not previously terminated on Date4. We further conclude that the termination of Y’s S
corporation election on Date4, or potentially thereafter, was inadvertent within the
meaning of § 1362(f). We further hold that, pursuant to the provisions of § 1362(f), X
will be treated as continuing to be an S corporation from Date4 and thereafter, provided
that X’s S corporation election was valid and provided that the election was not
otherwise terminated under § 1362(d) for reasons not addressed in this letter. Finally,
the election by Y to treat X as a QSub of Y remains valid and effective for the period
from Date4 to Date7.

   This ruling is contingent on the trustees of Trust1, Trust2, Trust3 and Trust4 filing

ESBT elections on behalf of their respective trusts, with effective dates of Date4, Date5,
Date5 and Date6, respectively, with the appropriate service center within 120 days of
the date of this letter. A copy of this letter should be attached to each election.

   Except as specifically set forth above, no opinion is expressed concerning the

federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed regarding Y’or X’s eligibility to be an S
corporation. In addition, no opinion is expressed as to whether Trust1, Trust2, Trust3
and Trust4 are eligible to elect to be treated as ESBTs.

   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 upon examination.

   This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)

of the Code provides that it may not be used or cited as precedent.
PLR-104972-20 6

  In accordance with the power of attorney on file with this office, we are sending

copies of this letter to X’s authorized representatives.

                                 Sincerely,



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

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

cc: