Inadvertent-termination relief for an S corporation after two successive shareholder trusts each missed the ESBT election

Plain-English summary

An S corporation had its stock pass through two trusts, and each time the trustee failed to file the election needed to keep the trust an eligible shareholder. When the original shareholder died, the stock went to a first trust, which qualified as a shareholder for only two years; after that window it needed to elect electing small business trust (ESBT) status, but the trustee never did, so the company's S election terminated. Later the stock moved to a second trust when the first trust's beneficiary died, and that trustee also missed the ESBT election. Both trusts otherwise met the ESBT rules, and everyone had filed returns consistent with valid S and ESBT status throughout. The corporation asked for relief under section 1362(f), representing the lapses were inadvertent and not tax-motivated. The IRS agreed and ruled the company will be treated as continuing to be an S corporation from the first termination date, contingent on both trustees filing ESBT elections (effective as of the respective dates) within 120 days and everyone filing conforming returns. If those conditions are not met, the ruling is void. This cleans up a chain of missed trust elections that would otherwise have ended the company's S status.

Ruling snapshot

• Question: Was the S election's termination inadvertent when two successive shareholder trusts each failed to make a timely ESBT election, and can section 1362(f) restore S status?
• Outcome: Approved (treated as a continuing S corporation, contingent on both trusts filing ESBT elections and conforming returns within 120 days).
• Key authorities: IRC § 1362(f); IRC § 1361(c)(2), (e); IRC § 1362(d)(2); Treas. Reg. §§ 1.1361-1(m), 1.1362-4(d).

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202209003                                             [Third Party Communication:
 Release Date: 3/4/2022                                        Date of Communication: Month DD, YYYY]
 Index Number: 1362.00-00, 1362.04-00
                                                               Person To Contact:
 ------------------------------------                          --------------------------, ID No. ----------------
 ----------------------------------------------                -----------------
 ------------------------------------------                    Telephone Number:
 -----------------------------------                           --------------------
                                                               Refer Reply To:
 -----------------------------------                           CC:PSI:B01
                                                               PLR-112172-21
                                                               Date:
                                                               December 03, 2021




LEGEND
 A     = -----------------------
         ------------------------

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

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

 Trust 2 = -----------------------------------------
           ------------------------
 State   = --------------

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

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

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

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


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

      This letter responds to a letter dated March 15, 2021, and subsequent
correspondence, submitted on behalf of X by X's authorized representatives, requesting
inadvertent termination relief pursuant to § 1362(f) of the Internal Revenue Code (the
'Code').
PLR-112172-21                                2

                                          FACTS

       According to the information submitted, X was incorporated on Date 1 under the
laws of State and elected to be treated as a subchapter S corporation effective Date 1.
A died on Date 2. A's shares of stock in X were transferred to Trust 1 on Date 2. Trust
1 qualified under § 1362(c)(2)(A)(iii) as an eligible shareholder for two years from Date

2. However, Trust 1 continued to hold X stock after the two-year period. X represents
that Trust 1 satisfied the electing small business trust (ESBT) requirements under §
1361(e). However, the trustee of Trust 1 failed to make an election under § 1361(e) to
treat Trust 1 as an ESBT effective Date 3. Accordingly, Trust 1 became an ineligible
shareholder of X and X's S corporation election terminated on Date 3.

        On Date 4, upon the death of Trust 1's beneficiary, shares of X were transferred
from Trust 1 to Trust 2. X represents that Trust 2 satisfied the electing small business
trust (ESBT) requirements under § 1361(e). However, the trustee of Trust 2 failed to
make a timely ESBT election. Accordingly, Trust 2 was an ineligible shareholder of X.
Had X's S corporation election not terminated on Date 3, it would have terminated on
Date 4.

       X further represents that X and its shareholders have filed their income tax
returns consistent with X having a valid S election for all taxable years since X elected
to be an S corporation, and Trust 1 and Trust 2 have filed consistently as ESBTs since
receiving shares in X. X represents that Trust 1 and Trust 2's failure to file timely ESBT
elections and the resulting termination of X's S corporation election were inadvertent
and were not motivated by tax avoidance or retroactive tax planning. Further, X and its
shareholders agree to make any adjustments required as a condition of obtaining relief
under § 1382(f) that 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)(B) provides that, for purposes of subchapter S, the term
"small business corporation" means a domestic corporation which is not an eligible
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 1 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.
PLR-112172-21                                 3

       Section 1361(c)(2)(A)(v) provides that for the purposes of § 1362(b)(1)(B), an
electing small business trust may be a shareholder.

         Section 1361(e)(1)(A) provides that for purposes of § 1361, 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), (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 than 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 consent of the
Secretary.

       Section 1.1361-1(m)(2)(i) of the Income Tax regulations provides, in part, that the
trustee of the trust 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(d)(2)(A) provides that 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.

        Section 1362(f) provides 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 discover 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 in such corporation at any time
during the period specified pursuant to § 1362(f), agrees to make such 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 termination, such corporation shall be treated as an S
corporation during the period specified by the Secretary.

       Section 1.1362-4(d) provides, in part, that the Commissioner may require any
adjustments that are appropriate. In general, the adjustments should be consistent with
the treatment of the corporation as an S corporation during the period specified by the
Commissioner.

                                      CONCLUSION
PLR-112172-21                                 4

        Based solely on the facts submitted and representations made, we conclude that
X's S corporation election terminated beginning on Date 3 when the trustee of Trust 1
failed to file an ESBT election under § 1361(e)(3). We further conclude that the
termination of X's S corporation election was inadvertent within the meaning of §
1362(f). Therefore, under § 1362(f), X will be treated as continuing to be an S
corporation on and after Date 3, provided X's S corporation election was otherwise valid
and not otherwise terminated under § 1362(d).

        This ruling is contingent on the following conditions: (1) the trustee of Trust 1
must file with the appropriate service center within 120 days from the date of this letter
an ESBT election effective Date 3; (2) the trustee of Trust 2 must file with the
appropriate service center within 120 days from the date of this letter an ESBT election
effective Date 4; and (3) X and its shareholders must file any original and amended
returns for all open taxable years 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 representative.

                                       Sincerely,



                                   By: _/s/________________________
                                       Laura C. Fields
                                       Branch Chief, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosure (1):
PLR-112172-21                              5

      Copy of this letter for § 6110 purposes




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