S corporation received relief after four trusts missed ESBT elections

Plain-English summary

An S corporation shareholder transferred stock to a grantor trust. When the shareholder died, the trust remained an eligible S corporation shareholder for two years, but its trustee failed to make an ESBT election when that period expired, terminating the corporation's S election. The first trust later distributed the shares to three successor trusts whose trustee also failed to make timely ESBT elections, creating a second termination event. The corporation and its shareholders had filed consistently with S corporation treatment, represented that the failures were inadvertent, and agreed to required adjustments. The IRS allowed continuous S corporation status from the first termination date, conditioned on ESBT elections for the three successor trusts within 120 days and a specified payment within 45 days.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after one trust's post-death eligibility expired and three successor trusts missed ESBT elections?
• Outcome: approved (continuous S corporation treatment, subject to elections and payment)
• 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: 202250007                                             Third Party Communication: None
    Release Date: 12/16/2022                                      Date of Communication: Not Applicable
    Index Numbers: 1362.00-00, 1362.02-00,
                  1362.02-02, 1362.04-00                          Person To Contact:
                                                                  --------------------, ID No. -----------------
    ----------------------                                        Telephone Number:
    --------------------------------------------------------      --------------------
    -------------------------                                     Refer Reply To:
    ------------------------------                                CC:PSI:03
    -------------------------------------                         PLR-107447-22
                                                                  Date:
                                                                  September 06, 2022




Legend

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

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

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

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

Trust 3            =        ---------------------------------------------------------------------------------

Trust 4            =        -------------------------------------------------------------------------------

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

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

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

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

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

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

Date 6             =        -------------------
 PLR-107447-22                                   3


m               =         ------------------


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

       This letter responds to a letter dated April 7, 2022, and subsequent
correspondence submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code (Code).

                                               Facts

       The information submitted states that X was incorporated under the laws of State
on Date 1 and elected to be an S corporation effective Date 2. On Date 3, A, a
shareholder of X, transferred shares of X stock to Trust 1. Trust 1 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 1 ceased to qualify as a shareholder under
§ 1361(c)(2)(A)(i). Trust 1 continued to qualify as an eligible S corporation shareholder
under § 1361(c)(2)(A)(ii) for the 2-year period beginning on the day of A’s death.
Following the expiration of the 2-year period on Date 5, Trust 1 continued to hold shares
of X stock. It is represented that Trust 1 qualified as an electing small business trust
(ESBT) within the meaning of § 1361(e), but the trustee of Trust 1 failed to make an
ESBT election under § 1361(e)(3) effective Date 5. As a result, X's S corporation election
terminated on Date 5.

        On Date 6, pursuant to the terms of Trust 1, after the administration of A’s estate
had ended, Trust 1 transferred shares of X to Trust 2, Trust 3, and Trust 4. It is
represented that Trust 2, Trust 3, and Trust 4 qualified as ESBTs within the meaning of
§ 1361(e) effective Date 6, but the trustee of Trust 2, Trust 3, and Trust 4 failed to make
timely elections under § 1361(e)(3) to treat Trust 2, Trust 3, and Trust 4 as ESBTs
effective Date 6. Therefore, had X’s S corporation election not terminated on Date 5, it
would have terminated on Date 6 when shares of X stock were transferred to ineligible
shareholders.

        X represents that at all relevant times, X and its shareholders have filed federal
 tax returns consistent with X being an S corporation and Trust 2, Trust 3, and Trust 4
 as ESBTs. X represents that the termination of its S corporation election was
 inadvertent and was not motivated by tax avoidance or retroactive tax planning. 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.
PLR-107447-22                                  4

                                      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
one class of stock.

        Section 1361(c)(2)(A)(i) provides that 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
§ 1361(c)(2)(A)(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, may be an S corporation shareholder.

     Section 1361(c)(2)(A)(v) provides that an ESBT may be an S corporation
shareholder.

      Section 1361(e) 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 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 election (generally within the 16-day-and-2-month period beginning on the
day that the stock is transferred to the trust).
PLR-107447-22                                  5

      Section 1362(a) provides that a small business corporation may elect to be an S
corporation.

      Section 1362(d)(2)(A) provides that (A) 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 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 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 termination, such corporation shall be treated as an S corporation during the
period specified by the Secretary.

                                         Conclusion

        Based solely on the facts submitted and the representations made, we conclude
that X's S corporation election terminated on Date 5 when Trust 1 became an ineligible
shareholder. In addition, had X’s S corporation election not terminated on Date 5, we
conclude that it would have terminated on Date 6 when the trustee of Trust 2, Trust 3,
and Trust 4 failed to make elections timely under § 1361(e)(3) to treat Trust 2, Trust 3,
and Trust 4 as ESBTs effective Date 6. We further conclude that the circumstances
resulting in the termination of X's S corporation election were inadvertent within the
meaning of § 1362(f). Therefore, pursuant to provisions of § 1362(f), X will be treated as
continuing to be an S corporation from Date 5 and thereafter, provided that X’s S
corporation election was valid and was not otherwise terminated under § 1362(d) for
reasons not addressed in this letter.

      This ruling is contingent on the trustee of Trust 2, Trust 3, and Trust 4 filing within
120 days from the date of this letter ESBT elections effective Date 6 on behalf of Trust
2, Trust 3, and Trust 4 with the appropriate service center. A copy of this letter should
be attached to each ESBT election.

       Furthermore, as an adjustment under § 1362(f)(4), X must send a payment of $m
with a copy of this letter within 45 days from the date of this letter to the following
address: Internal Revenue Service, Kansas City Submission Processing Campus,
Attn.: Manual Deposit, 333 W. Pershing Road, Stop 7777, Kansas City, MO 64108.
PLR-107447-22                                   6

       If the above conditions are not met, then this ruling is null and void. Furthermore,
if these conditions are not met, X must notify the service center with which it filed its S
corporation election that its election terminated on Date 5.

         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 or Trust 2’s, Trust 3’s, or Trust 4’s eligibility to be
ESBTs.

      This ruling is directed only to the taxpayer who requested it. According to
§ 6110(k)(3) of the Code, 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 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 the Associate Chief Counsel
                                          (Passthroughs & Special Industries)




Enclosure:
      Copy of this letter for § 6110 purposes


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