S corporation keeps its status after a trust missed its ESBT election, ruled an inadvertent termination

Plain-English summary

A company taxed as an S corporation had its shares transferred to two trusts. One trust timely elected to be treated as an Electing Small Business Trust (ESBT), which is a permitted S corporation shareholder, but the second trust did not make its ESBT election on time. That miss technically terminated the company's S election on the transfer date, which would have turned it into a C corporation. The company represented that the failure was inadvertent, not motivated by tax avoidance, and that both trusts otherwise met the ESBT requirements. Section 1362(f) lets the IRS treat such a termination as if it never occurred when the lapse was inadvertent and the parties take corrective steps. The IRS ruled the termination inadvertent and preserved the company's S status retroactively, conditioned on the second trust filing a late ESBT election within 45 days, both trusts amending returns as needed, and specified payments being made. It matters because it is a routine but valuable rescue that keeps a company from being taxed as a C corporation over a single missed trust election.

Ruling snapshot

• Question: Was the termination of the company's S election, caused by a trust's failure to make a timely ESBT election, an inadvertent termination that can be excused?
• Outcome: Approved (S status preserved retroactively, subject to a 45-day cure and specified payments)
• Key authorities: IRC §§ 1361(b), 1361(c)(2), 1361(e), 1362(a), 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202147009 Third Party Communication: None
Release Date: 11/26/2021 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------- -----------------, ID No. -----------------
------------------------------------ Telephone Number:
--------------------------------------- ---------------------
-------------------------- Refer Reply To:
CC:PSI:03
PLR-107845-21
Date:
August 18, 2021

Legend:

Company: = -------------------------
-----------------------

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

A: = ----------------------

Trust 1: = ------------------------------------------------------------------------

Trust 2: = ----------------------------------------------------------------------------------------
--------

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

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

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

x = --------

y = --------
PLR-107845-21 2

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

  This letter responds to a letter dated February 26, 2021, and subsequent

correspondence, submitted on behalf of Company by its authorized representative,
requesting a ruling under § 1362(f) of the Internal Revenue Code (Code).

                                      FACTS

  The information submitted states Company was organized on Date 1, as a

corporation under the laws of State. Effective Date 2, Company elected to be taxed as
an S corporation.

   On Date 3, A transferred shares of Company to Trust 1, which timely elected to

be treated as an Electing Small Business Trust (ESBT) within the meaning of section
1361(e). Shares of Company were also transferred to Trust 2 on Date 3. However, a
timely ESBT election under section 1361(e)(3) was not made for Trust 2, causing
Company’s S election to terminate on Date 3.

   Company represents that each of Trust 1 and Trust 2 have at all times met the

requirements of an ESBT within the meaning of section 1361(e), except that the
trustees of the Trust 2 did not make a timely ESBT election under section 1361(e)(3).

    Company represents that upon discovering that its S election had terminated,

Company took corrective action by filing this request for relief. Company represents
that the failure to make timely ESBT elections was inadvertent and not motivated by tax
avoidance or retroactive tax planning. Company further represents that it has filed its
income tax returns consistent with having a valid S election in effect for all taxable years
since Company elected to be an S corporation. Company represents that other than
the failure to make a valid ESBT election for Trust 2 on Date 3, Company has qualified
as a small business corporation at all times since its election on Date 2. Lastly,
Company and its shareholders agree to make any adjustments required as a condition
of obtaining relief under § 1362(f) 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
PLR-107845-21 3

an individual; (C) have a nonresident alien as a shareholder; and (D) have more than
one 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.

   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, in relevant

part, 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 1362(a)(1) provides that except as provided in § 1362(g), a small

business corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

   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 to obtain shareholder consents, (2) the Secretary determines that the
circumstances resulting in such ineffectiveness were inadvertent; (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
ineffectiveness, steps were taken so that the corporation for which the election was
made is a small business corporation; and (4) the corporation for which the election was
made, 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, such corporation shall be treated as an S corporation during the
period specified by the Secretary.
PLR-107845-21 4

                                  CONCLUSION

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

that Company’s S corporation election terminated on Date 3 when the trustees of
Trust 2 failed to file an ESBT election for Trust 2 under § 1361(e)(3). We further
conclude that the termination of Company’s S election was inadvertent within the
meaning of § 1362(f). Therefore, under § 1362(f) Company will be treated as an
S corporation on and after Date 2, provided Company’s S corporation election was
otherwise valid and not otherwise terminated under § 1362(d).

   This ruling is contingent on the following: within 45 days of this letter (1) the

trustees of the Trust 2 filing an ESBT election effective Date 3, and (2) both Trust 1 and
Trust 2 filing any amended returns and making adjustments to properly reflect the
treatment of the trusts as ESBTs for all taxable years. A copy of this letter should be
attached to any elections or returns.

    Furthermore, as an adjustment under § 1362(f), a payment of $ x for Trust 1, and

$ y for Trust 2, and a copy of this letter ruling must be sent to the following address:

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

    The payment of this letter must be sent no later than 45 days after the date of

this letter.

    If the conditions are not met, this ruling is null and void. In addition, if these

conditions are not met, Company must send notification that its S corporation election
has terminated to the service center with which Company’s S election was filed.

  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.
PLR-107845-21 5

    Pursuant to the power of attorney on file with this office, we are sending a copy of

this letter to X’s authorized representative.

                                  Sincerely,

                                  Associate Chief Counsel
                                  (Passthroughs & Special Industries)



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

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

cc: