S corporation received relief after two trusts used late ESBT dates

Plain-English summary

Shares of an S corporation were transferred to two trusts that were eligible to become electing small business trusts (ESBTs). Their trustees filed ESBT elections with an effective date later than the transfer date, so the trusts were ineligible S corporation shareholders during the gap and the corporation's S election terminated. The corporation represented that the mistake was not tax-motivated, that it and its shareholders had filed consistently with S corporation treatment, and that they would make required adjustments. The IRS treated the termination as inadvertent and allowed the corporation to retain continuous S status. Relief required corrected ESBT elections effective on the transfer date and consistent original or amended returns within 120 days.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief when two shareholder trusts filed ESBT elections effective after they acquired its shares?
• Outcome: approved (continuous S corporation treatment, subject to corrected elections and returns)
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 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: 202251001                                               Third Party Communication: None
 Release Date: 12/23/2022                                        Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                                 Person To Contact:
 --------------------------------------                          -----------------, ID No. -----------------
 ------------------------------                                  Telephone Number:
 --------------------------                                      --------------------
 -------------                                                   Refer Reply To:
 ------------------------                                        CC:PSI:03
                                                                 PLR-105854-22
                                                                 Date:
                                                                 September 16, 2022




Legend:

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

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

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

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

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

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

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

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



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

      This letter responds to a letter dated February 25, 2022, and subsequent
correspondence, submitted on behalf of Company by its authorized representative,
requesting a ruling under § 1362(f) of the Internal Revenue Code (Code).
PLR-105854-22                                2


                                          FACTS

       The information submitted states Company was organized on Date 1, under the
laws of State. Effective Date 2, Company elected to be taxed as an S corporation.

        On Date 3, shares of Company were transferred to Trust 1 and Trust 2
(collectively “Trusts”). As of Date 3, Trusts were eligible to elect to be treated as
Electing Small Business Trusts (ESBTs) within the meaning of section 1361(e).
However, the trustees of Trusts filed elections for Trusts to be treated as ESBTs
effective Date 4 rather than Date 3. Accordingly, Company’s S corporation election
terminated effective Date 3, because membership interests in Company were
transferred to Trusts, which were at that time ineligible shareholders.

       Company represents that the termination was not motivated by tax avoidance or
retroactive tax planning. Company further represents that Company and its
shareholders have filed their respective income tax returns consistent with Company’s S
corporation election. Company and its shareholders have agreed to make any
adjustments that the Secretary may require, consistent with the treatment of Company
as an S corporation.

                                  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
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.
PLR-105854-22                                  3

       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.

                                       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 Trusts
failed to file an ESBT elections 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 120 days of this letter (1) the
trustees of the Trusts filing an ESBT election effective Date 3, and (2) Company and its
shareholders filing 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
any elections or returns.
PLR-105854-22                                 4

       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.

        Pursuant to the power of attorney on file with this office, we are sending a copy of
this letter to Company’s authorized representative.


                                      Sincerely,



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



Enclosures :
      Copy of this letter for § 6110 purposes




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