S corporation receives relief for two late ESBT elections

Plain-English summary

Two trusts became shareholders of an S corporation but did not timely elect electing small business trust status, making them ineligible shareholders and terminating the corporation's S election. The trusts represented that they had always met the substantive ESBT requirements, and the corporation, trusts, and other shareholders had consistently filed as though the corporation remained an S corporation and the trusts were ESBTs. The corporation also represented that the failure was inadvertent, was not motivated by tax avoidance or retroactive planning, and that all affected parties would make any required adjustments. The IRS granted inadvertent-termination relief under Section 1362(f), treating the corporation as an S corporation continuously from the termination date. The ruling required both trusts to file effective-date ESBT elections and all affected parties to file consistent original or amended returns within 120 days. Failure to satisfy those conditions would make the ruling void.

Ruling snapshot

• Question: Could the corporation retain continuous S status after two shareholder trusts failed to file timely ESBT elections?
• Outcome: Approved, conditioned on ESBT elections and consistent returns within 120 days
• Key authorities: IRC §§ 1361(c)(2), 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: 202140015                                             Third Party Communication: None
Release Date: 10/8/2021                                       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:B01
------------------------                                      PLR-128367-20
----------------------------                                  Date:
                                                              June 10, 2021




LEGEND
X                   =     --------------------------------------------------------------------------------------------------------
                          -----------------------------------------------------
Trust 1             =     --------------------------------------------------------------------------------------------------------
                          -------------------------------------
Trust 2             =     --------------------------------------------------------------------------------------------------------
                          -------------------------------------
Date 1              =     ------------------

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

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

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


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

This responds to a letter dated December 8, 2020, and supplemental information,
submitted on behalf of X by X's authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

FACTS
PLR-128367-20                                2

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.

On Date 3, Trust 1 and Trust 2 became shareholders of X. However, Electing Small
Business Trust (ESBT) elections effective Date 3 were not timely filed for either Trust 1
or Trust 2. Accordingly, Trust 1 and Trust 2 were ineligible shareholders of X and X's S
corporation status was terminated.

X represents that Trust 1 and Trust 2 have at all times since Date 3 met the
requirements of an ESBT within the meaning of § 1361(e). X also represents that X and
its shareholders have filed consistently with X’s treatment as an S corporation, and
Trust 1 and Trust 2 have filed consistently as ESBTs, at all times since Date 3. In
addition, X represents that the termination of its S corporation status was inadvertent
and was not motivated by tax avoidance or retroactive tax planning. Further, X
represents that X and its shareholders agree to make any adjustments required as a
condition of obtaining relief for the termination of X’s election as provided under §
1362(f) of the Code that may be required by the Secretary.

LAW AND ANALYSIS

Section 1361(a)(1) of the Code 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 § 1362(b)(1)(B), an electing
small business trust (ESBT) may be an S corporation 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
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 “electing small business trust” shall 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,
PLR-128367-20                                 3

(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 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(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation 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
was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that the
circumstances resulting in such ineffectiveness or termination were inadvertent; (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
such ineffectiveness or termination, steps were taken so that the corporation for which
the election was made or termination occurred is a small business corporation; and (4)
the corporation for which the election was made or 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
ineffectiveness or 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 status inadvertently terminated within the meaning of § 1362(f) on Date 3
because Trust 1 and Trust 2 were ineligible shareholders. Pursuant to the provisions of
§ 1362(f), X will be treated as an S corporation from Date 3 and thereafter, provided X's
S corporation election is otherwise effective and not terminated under § 1362(d).

This letter ruling is contingent upon the following conditions being met within 120 days
from the date of this letter: (1) elections to treat Trust 1 and Trust 2 as ESBTs effective
Date 3, must be made with the appropriate service center; and (2) X and its
shareholders must file any original and amended returns for all open taxable years
PLR-128367-20                                  4

consistent with the relief granted in this letter. A copy of this letter should be attached to
the ESBT elections. If these conditions are not met, then this ruling is null and void.

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.

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.

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,


                                       Laura Fields

                                       Laura Fields, Chief
                                       Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)


Enclosure
      Copy for § 6110 purposes



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