Missing ESBT elections caused an inadvertent S corporation termination

Plain-English summary

An S corporation transferred shares to four trusts that qualified to be electing small business trusts, but their trustees did not file the required ESBT elections. The trusts therefore became ineligible shareholders and terminated the corporation's S election. The IRS found that the termination was inadvertent because no one intended it and the omission was not motivated by tax avoidance or retroactive planning. The corporation will be treated as continuously qualifying as an S corporation if the trustees file effective ESBT elections within 120 days, the affected parties file required amended returns and adjustments, and the corporation makes the specified redacted payment by the stated deadline. Failure to satisfy every condition makes the ruling null and void.

Ruling snapshot

• Question: Was the S corporation termination caused by four missing ESBT elections inadvertent under Section 1362(f)?
• Outcome: Approved, subject to filing, adjustment, and payment conditions.
• Key authorities: IRC §§ 1361(e), 1362(d), 1362(f), 1366, 1367, 1368; Treas. Reg. §§ 1.1361-1(m)(2)(i), 1.1362-4(d)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202124004 Third Party Communication: None
Release Date: 6/18/2021 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
Person To Contact:
----------------------------------------------- ----------------------, ID No. ------------------
------------------------------------ Telephone Number:
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----------------------------------------- Refer Reply To:
CC:PSI:B3
PLR-121017-20
Date:
March 2, 2021

                   LEGEND

X = ----------------------------------------------
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A = ----------------------------------------------
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B = ------------------

Trust = ----------------------------------------------
1 ----------------------------------------------
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Trust = ----------------------------------------------
2 ----------------------------------------------
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Trust = ----------------------------------------------
3 ----------------------------------------------
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Trust = ----------------------------------------------
4 ----------------------

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

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

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

PLR-121017-20
Date 3 = ------------------------------

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

Year = -------

n = --------------

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

This letter responds to a letter dated September 18, 2020, and subsequent
correspondence, written on behalf of X, requesting a ruling under § 1362(f) of the
Internal Revenue Code.

                                        Facts

   X was incorporated under the laws of State on Date 1. X elected to be an S

corporation effective Date 2. On Date 3, shares of X’s stock were transferred to Trust 1,
Trust 2, Trust 3, and Trust 4. X represents that Trust 1, Trust 2, Trust 3, and Trust 4,
were qualified to be Electing Small Business Trusts (ESBTs), within the meaning of
§ 1361(e), however, no election was made under § 1361(e)(3) to treat Trust 1, Trust 2,
Trust 3, and Trust 4 as ESBTs. Consequently, Trust 1, Trust 2, Trust 3, and Trust 4
were ineligible shareholders, and, as a result, X’s S corporation election terminated on
Date 3.

   X represents that there was no intent to terminate X’s S corporation election and

that the failure to timely file the ESBTs elections for Trust 1, Trust 2, Trust 3, and Trust 4
were inadvertent and not motivated by tax avoidance or retroactive tax planning. X and
X’s shareholders agree to make any adjustments consistent with the treatment of X as
an S corporation as may be required by the Secretary with respect to the period
specified by § 1362(f).

                                   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 shareholder 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
PLR-121017-20 3

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

is a permissible shareholder.

   Section 1361(e)(1)(A) provides that, except as provided in § 1361(e)(1)(B), the

term “electing small business trust” 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)-(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 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 an

electing small business trust (ESBT) means any trust if it meets the following
requirements: the trust does not have as a beneficiary any person other than an
individual, an estate, an organization described in § 170(c)(2) through (5), or an
organization described in § 170(c)(1) that holds a contingent interest in such trust and is
not a potential current beneficiary; no interest in the trust has been acquired by
purchase; and the trustee of the trust makes a timely ESBT election for 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 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 was terminated under § 1362(d)(2) or (3); (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 of the corporation at any
time during the period specified pursuant to § 1362(f), agrees to make the adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to this period, then, notwithstanding the
circumstances resulting in the termination, the corporation shall be treated as an S
corporation during the period specified by the Secretary.
PLR-121017-20 4

  Section 1.1362-4(d) of the Income Tax Regulations provides that the

Commissioner may require any adjustments that are appropriate. In general, the
adjustments required should be consistent with the treatment of the corporation as an S
corporation during the period specified by the Commissioner.

                                   Conclusion

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

X’s S corporation election was terminated on Date 3 when stock in X was transferred to
Trust 1, Trust 2, Trust 3, and Trust 4 because Trust 1, Trust 2, Trust 3, and Trust 4
failed to timely file ESBTs election under § 1361(e)(3). We further conclude that the
termination was inadvertent within the meaning of § 1362(f). Pursuant to the provisions
of § 1362(f), X will be treated as continuing to be an S corporation on and after Date 3,
unless X’s S corporation election is otherwise terminated under § 1362(d). The trustee
of Trust 1, Trust 2, Trust 3, and Trust 4 must file an ESBT election effective Date 3 with
the appropriate service center within 120 days of the date of this letter. A copy of this
letter should be attached to the ESBT elections.

   This ruling is contingent upon X and each of its shareholders filing any amended

returns and making such adjustments that are necessary to properly reflect the
reporting of X’s items of S corporation income. Specifically, Trust 1, Trust 2, Trust 3,
and Trust 4 must file amended returns and make adjustments that are necessary to
properly reflect the treatment of Trust 1, Trust 2, Trust 3, and Trust 4 as ESBTs for Year
taxable year. In addition, the shareholders of X must include in their income their pro
rata share of separately stated and nonseparately computed items of X as provided in
§ 1366 and make any adjustments to basis as provided in § 1367, and take into account
any distributions made by X as provided in § 1368.

    Additionally, as an adjustment under § 1362(f), a payment of $n and a copy of

this letter ruling must be sent to the following address:

                       Kansas City Service Center
                       333 W. Pershing Road
                       Kansas City, MO 64108
                       Stop 7777
                       Attn: Manual Deposit

   This letter must be sent no later than Date 4.

   A copy of this letter must be attached to any income tax return to which it is

relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.
PLR-121017-20 5

    If all of the above conditions are not met, then this ruling is null and void.

Furthermore, if these conditions are not met, X must notify the Ogden Service Center
that its S corporation election has terminated.

     Except for the specific ruling above, no opinion is expressed or implied

concerning the federal tax consequences of the facts of this case under any other
provision of the Code. Specifically, no opinion is expressed or implied regarding X’s
eligibility to be an S corporation or Trust 1, Trust 2, Trust 3, and Trust 4’s eligibility to be
ESBTs.

  The rulings contained in this letter are 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 request for rulings, 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.

    Under a power of attorney on file with this office, we are sending a copy of this

letter to your authorized representative.

                                        Sincerely,


                                        ________________
                                        Richard T. Probst
                                        Senior Technician Reviewer, Branch 3
                                        Office of Associate Chief Counsel
                                        (Passthroughs & Special Industries)

Enclosures (2):

   A copy of this letter
   A copy for § 6110 purposes

cc: