Inadvertent-termination relief for an S corporation after a shareholder trust missed its ESBT election following the owner's death

Plain-English summary

An S corporation had shares held by a grantor trust, which is an allowed S corporation shareholder while the grantor is alive. When the grantor died, the trust could keep holding the stock for only two more years unless it elected to become an electing small business trust (ESBT), a permitted shareholder type. The trustee never filed that ESBT election, so when the two-year grace period ended the trust became an ineligible shareholder and the corporation's S election automatically terminated. The corporation asked the IRS for relief under section 1362(f), representing that the lapse was inadvertent and that it had kept filing as an S corporation. The IRS agreed the termination was inadvertent and ruled the corporation will be treated as continuing to be an S corporation from the termination date forward. Relief is contingent on the trustee filing the ESBT election, effective as of that date, within 120 days. This rescues the company's S status from a missed trust election triggered by the shareholder's death.

Ruling snapshot

• Question: Was the termination of the S election inadvertent when a shareholder trust failed to make its ESBT election after the grantor's death, and can section 1362(f) restore S status?
• Outcome: Approved (treated as a continuing S corporation, contingent on filing the ESBT election within 120 days).
• Key authorities: IRC § 1362(f); IRC § 1361(c)(2), (e); IRC § 1362(d)(2); Treas. Reg. § 1.1361-1(m).

Full text (IRS public release)

 Internal Revenue Service                                 Department of the Treasury
                                                          Washington, DC 20224

 Number: 202209005                                        Third Party Communication: None
 Release Date: 3/4/2022                                   Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                          Person To Contact:
 ------------------------------                           ------------------------, ID No. -----------------
 -----------------------------                            Telephone Number:
 ----------------------                                   --------------------
 --------------------------------                         Refer Reply To:
 -----------------------------------------------------    CC:PSI:B01
                                                          PLR-113267-21
                                                          Date:
                                                          December 07, 2021




                                                    LEGEND

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

 A             =        ------------------------

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

 State         =        ---------

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

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

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

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

 Date 5        =        -------------------------

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

This responds to a letter dated April 29, 2021, and subsequent correspondence,
submitted on behalf of X by its authorized representatives, requesting a ruling under
§ 1362(f) of the Internal Revenue Code (the Code).
PLR-113267-21                                 2

                                           Facts

The information submitted states that X was incorporated under the laws of State on
Date 1. X elected to be treated as a small business corporation effective Date 2.
On Date 3, A, an individual, transferred shares of X stock to Trust. Trust was treated
(under subpart E of part I of subchapter J of chapter 1 of the Code) as a grantor trust
owned by A until Date 4 when A died and Trust ceased to qualify as a shareholder
under § 1361(c)(2)(A)(i). Trust continued to qualify as an eligible S corporation
shareholder for the two-year period beginning on the day of A's death and ending
Date 5 under § 1361(c)(2)(A)(ii).

X represents that Trust qualifies as an electing small business trust (ESBT) within the
meaning of § 1361(e). However, the trustee failed to make an election under
§ 1361(e)(3) to treat Trust as an ESBT effective Date 5. As a result, X's S corporation
election terminated on Date 5.

X represents that the failure to file the ESBT election resulting in the termination of X's S
corporation election was inadvertent and unintended. X further represents that for each
taxable year since X elected to be an S corporation, X and its shareholder have filed
their federal income tax returns consistent with X being an S corporation. Further, X and
its shareholder have agreed to make any adjustments that the Commissioner may
require, consistent with the treatment of X as an S corporation.

                                            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)(ii) provides that a trust which was described in clause (i)
immediately before the death of the deemed owner and which continues in existence
after such death, but only for the 2-year period beginning on the day of the deemed
owner's death.
PLR-113267-21                                 3

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

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 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
Qualified Subchapter S Trust election (generally within the 16-day-and-2-month period
beginning on the day that the stock is transferred to the trust).

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
PLR-113267-21                                 4

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 terminated on Date 5 when Trust became an ineligible
shareholder. We conclude that the termination of X's S corporation election was
inadvertent within the meaning of § 1362(f). Accordingly, pursuant to the provisions of
§ 1362(f), X will be treated as continuing to be an S corporation from Date 5 and
thereafter, provided X's S corporation election was valid and not otherwise terminated
under § 1362(d).

This ruling is contingent on the trustee of Trust filing an ESBT election effective Date 5
with the appropriate service center within 120 days of the date of this letter. A copy of
this letter should be attached the 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 on 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 representative.


                                          Sincerely,

                                          /s/ Jennifer N. Keeney

                                           Jennifer N. Keeney
                                           Senior Counsel, Branch 1
                                           Office of the Associate Chief Counsel
                                           (Passthroughs & Special Industries)


Enclosure
      Copy for § 6110 purposes
PLR-113267-21                                             5

cc:

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