IRS grants inadvertent-termination relief under section 1362(f) where an eligible trust shareholder never filed the ESBT election, ineffective S election restored

Plain-English summary

A corporation filed Form 2553 to be taxed as an S corporation, and all of its shares were held by a trust. The trust qualified as an electing small business trust (ESBT), one of the few trust types allowed to own S corporation stock, but the trustee never filed the required ESBT election under section 1361(e)(3). Because the trust was therefore an ineligible shareholder, the corporation's S election was never effective. The corporation asked the IRS for relief under section 1362(f), representing that the failure was inadvertent, not tax-motivated, and that it and its shareholders had filed consistently as an S corporation. The IRS granted relief. It found the ineffectiveness inadvertent, so the corporation will be treated as an S corporation from the intended effective date, provided the trustee files the proper ESBT elections within 120 days of the letter.

Ruling snapshot

• Question: Was the corporation's ineffective S election (caused by the trustee's failure to file a timely ESBT election) inadvertent, so that S status can be restored under section 1362(f)?
• Outcome: Approved (relief granted, conditioned on filing ESBT elections within 120 days)
• Key authorities: IRC § 1362(f); IRC § 1361(c)(2), (e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202142006
Third Party Communication: None
Release Date: 10/22/2021
Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00,
1361.03-00, 1361.03-03
Person To Contact:
--------------------, ID No. -----------------
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Telephone Number:
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Refer Reply To:
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CC:PSI:03
PLR-103185-21
Date:
July 22, 2021

Legend

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

Trust = ------------------------

Country = ------------

State = ---------

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

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

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

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

This responds to a letter dated January 19, 2021, and subsequent correspondence, submitted on behalf of X by its authorized representatives, requesting a ruling under § 1362(f) of the Internal Revenue Code.

FACTS

The information submitted states that X was incorporated under the laws of Country on Date 1. On Date 2, all shares of X were transferred to Trust. X was converted to a State corporation on Date 3 and also filed Form 2553, Election by a Small Business Corporation, to elect to be an S corporation, also effective Date 3. X represents that Trust was qualified to be an electing small business trust (ESBT) within the meaning of § 1361(e). However, no election was made under § 1361(e) to treat
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Trust as an ESBT. Consequently, Trust was an ineligible shareholder, and, as a result, X’s S corporation election was ineffective. X represents that Trust has at all times met the requirements of an ESBT within the meaning of § 1361(e), except that the trustee did not file a timely ESBT election under § 1361(e)(3).

X represents that the circumstances resulting in the ineffectiveness of X’s S corporation election were inadvertent and were not motivated by tax avoidance or retractive tax planning. Additionally, X represents that X and its shareholders have filed their federal income tax returns consistent with having a valid S corporation election in effect for X. Further, X and its shareholder 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) 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)(B) provides that the term “small business corporation” means a domestic corporation which is not an ineligible corporation and which does not 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.

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 I of subchapter J of chapter 1) as owned by an individual who is a citizen or resident of the United States may be an S corporation shareholder.

Section 1361(c)(2)(A)(v) provides that, for purposes of § 1362(b)(1)(B), an ESBT is a permitted shareholder of a small business corporation.

Section 1361(d)(1) provides that in the case of a QSST for which a beneficiary makes an election under § 1361(d)(2), the trust is treated as a trust described in § 1361(c)(2)(A)(i), and for purposes of § 678(a), the beneficiary of the trust shall be treated as the owner of that portion of the trust that consists of stock in an S corporation with respect to which the election under § 1361(d)(2) is made.

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
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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 1361(d)(2)(A) provides that a beneficiary of a QSST may elect to have § 1361(d) apply. Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary of a QSST must make the election under § 1361(d)(2) by signing and filing with the service center with which the corporation files its income tax returns the applicable form or a statement including the information listed in § 1.1361-1(j)(6)(ii).

Section 1362(d)(2) provides that (A) in general, 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, and (B) any termination under § 1362(d)(2) shall be effective on and after the date of cessation.

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

Based solely on the representations made and the information submitted, we conclude that X's S corporation election was ineffective as of Date 3 because Trust was an ineligible shareholder. We conclude that the ineffectiveness of X's S corporation election was inadvertent within the meaning of § 1362(f).
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Accordingly, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S corporation from Date 3 and thereafter, provided X's S corporation election was valid and not otherwise terminated under § 1362(d).

This ruling is contingent on X and its shareholders treating X as having been an S corporation for the period beginning Date 3 and thereafter. The trustees of Trust must file appropriate ESBT elections 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 each ESBT election.

Except as specifically set forth above, we express or imply no opinion concerning the federal tax consequences of the transactions described above under any other provision of the Code. Specifically, we express or imply no opinion regarding X's eligibility to be an S corporation or the eligibility of Trust to be an ESBT.

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. Section 6110(k)(3) provides that it may not be used or cited as precedent. Pursuant to a power of attorney on file, a copy of this letter is being sent to X's authorized representatives.

Sincerely,

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

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

cc: