S corporation's accidental termination excused after a trust missed its ESBT election deadline

Plain-English summary

An S corporation had a trust as one of its shareholders. While the trust's original owner was alive, the trust was a grantor trust wholly owned by that person, which made it a permissible S corporation shareholder. When the owner died, the trust could keep holding the shares for only two years unless it made a special election to become an "electing small business trust" (ESBT). The trustee did not file that ESBT election in time, so once the two-year window closed the corporation quietly lost its S corporation status. The company said the lapse was an honest mistake, not tax planning, and that everyone had kept filing as if the S election were still in effect. The IRS agreed the termination was inadvertent under section 1362(f) and ruled that the corporation may be treated as continuing to be an S corporation, as long as the trustee now files the missing ESBT election (effective as of the owner's death) within 120 days of the ruling letter. This spares the company from the costly tax consequences of an accidental S-election termination.

Ruling snapshot

• Question: Was the termination of the corporation's S election, caused by a trust's failure to timely file its ESBT election, inadvertent under IRC § 1362(f) so the S status can be restored?
• Outcome: Approved (inadvertent termination relief granted, contingent on filing the ESBT election within 120 days)
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 1362(d)(2), 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: 202233001 Third Party Communication: None
Release Date: 8/19/2022 Date of Communication: Not Applicable
Index Numbers: 1361.03-03, 1362.00-00,
1362.04-00 Person To Contact:
----------------------, ID No. ------------------
Telephone Number:
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--------------------------------- Refer Reply To:
---------------------------------- CC:PSI:B3
--------------------------- PLR-100252-22
---------------------------------- Date:
May 25, 2022

                                           LEGEND

X = ----------------------------------------------
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A = ----------------------------------------------
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Trust = ----------------------------------------------
----------------------

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

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

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

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

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

Dear ---------------:
PLR-100252-22 2

   This letter responds to a letter dated December 7, 2021, and subsequent

correspondence, written on behalf of X, requesting a ruling under § 1362(f) of the
Internal Revenue Code (Code).

                                     FACTS

   X was incorporated under the laws of State on Date 1 and elected to be an S

corporation effective Date 2. Trust owned shares of stock in X. Trust was treated under
subpart E of part I of subchapter J of chapter 1 as entirely owned by A and, thus, was a
permissible shareholder under § 1361(c)(2)(A)(i). On Date 3, A died and Trust ceased
to be a permissible shareholder under § 1361(c)(2)(A)(i). Under § 1361(c)(2)(A)(ii),
Trust remained an eligible shareholder for a 2-year period beginning on the day of A’s
death. X represents that beginning on Date 3, Trust was eligible to be an electing small
business trust (“ESBT”) under § 1361(e)(1), but the trustee of Trust did not timely file an
ESBT election under § 1361(e)(3). As a result, X’s S corporation election terminated on
Date 4 when Trust continued to hold shares of stock in X after the 2-year period in
§ 1361(c)(2)(A)(ii) ended.

   X represents that there was no intent to terminate X’s S corporation election and

that the failure to file the ESBT election for Trust was inadvertent and not motivated by
tax avoidance or retroactive tax planning. Further, X represents that Trust has filed its
income tax returns consistent with being an ESBT since Date 3 and that X and its
shareholders have filed consistently with X being an S corporation since Date 2.
Finally, X and its shareholders agree to make any adjustments consistent with the
treatment of X as an S corporation as may be required by the Secretary with respect to
the period specified by § 1362(f).

                              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) 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)(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.
PLR-100252-22 3

   Section 1361(c)(2)(A)(ii) provides that for purposes of § 1361(b)(1)(B), a trust

which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed
owner and which continues in existence after such death may be an S corporation
shareholder, but only for the 2-year period beginning on the day of the deemed owner’s
death.

 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, 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)-(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 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 § 1.1361-2(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(d)(2)(B) provides that any termination under
§ 1362(d)(2) shall be effective on and after the date of cessation.

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

by any corporation was terminated under § 1362(d)(2); (2) the Secretary determines
that the circumstances resulting in such termination were inadvertent; (3) no later than a
reasonable period of time after discovery 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 the corporation at any time during
the period specified pursuant to § 1362(f), agrees to make the 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 termination, the corporation shall be treated as an S corporation during the period
specified by the Secretary.
PLR-100252-22 4

                                  CONCLUSION

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

X’s S corporation election terminated on Date 4 when Trust became an ineligible
shareholder. We further conclude that the circumstances resulting in the termination
were 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 on and
after Date 4, 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 3 with the appropriate service center within 120 days from the date of this letter. A
copy of this letter should be attached to the ESBT election.

   Except for the specific ruling 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 or Trust’s eligibility 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 who requested it. According to

§ 6110(k)(3), this ruling may not be used or cited as precedent.

    Under a power of attorney on file with this office, we are sending a copy of this

letter to your authorized representatives.

                                      Sincerely,


                                      Mary Beth Carchia
                                      Senior Technician Reviewer, Branch 3
                                      Office of Associate Chief Counsel
                                      (Passthroughs & Special Industries)

Enclosure:
A copy of this letter for § 6110 purposes

cc: