Missed ESBT election does not end S corporation status

Plain-English summary

After a shareholder died, S corporation shares passed under the shareholder's will to a trust that could hold the stock for two years without a special election. The trust was eligible to be an electing small business trust, but its trustees did not file an ESBT election before that two-year period expired. The corporation's S election therefore technically terminated when the temporary eligibility ended. The IRS found that the termination was inadvertent and treated the corporation as continuously maintaining S status. The relief requires the trust to file consistent original or amended returns for all open years and the trustees to file an ESBT election effective from the termination date, both within 120 days.

Ruling snapshot

• Question: Can an S corporation retain continuous S status when trustees miss the ESBT election after a testamentary trust's two-year holding period expires?
• Outcome: Approved, subject to returns and a retroactive ESBT election within 120 days
• Key authorities: IRC §§ 1361(c), 1361(e), 1362(d), and 1362(f); Treas. Reg. § 1.1361-1(m)(2)

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202315003                                              Third Party Communication: None
 Release Date: 4/14/2023                                        Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                                Person To Contact:
 -------------------------------                                --------------------, ID No. -----------------
 ------------------------------------------------               Telephone Number:
 -------------------------------------------                    --------------------
 --------------------------------                               Refer Reply To:
 ----------------------------------                             CC:PSI:B03
                                                                PLR-113859-22
                                                                Date:
                                                                January 12, 2023




LEGEND:

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

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

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

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

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

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

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

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


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

       This letter responds to a letter dated June 23, 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”).
PLR-113859-22                                 2

                                          FACTS

       The information submitted states that X was incorporated on Date 1 under the
laws of State and elected to be an S corporation effective Date 1. A owned shares of X
stock.

        On Date 2, A died. Pursuant to the terms of A’s will, shares of X stock were
transferred to Trust on Date 3. For a 2-year period beginning on Date 3, Trust was an
eligible shareholder of X under § 1361(c)(2)(A)(iii). X represents that Trust was eligible
to be an electing small business trust (“ESBT”) under § 1361(e)(1), however, the
trustees of Trust failed to file an ESBT election for Trust. As a result, X’s S corporation
election terminated on Date 4 when the 2-year period under § 1361(c)(2)(A)(iii) ended.

        X represents that there was no tax avoidance or retroactive tax planning involved
in the failure of the trustees to file an ESBT election for Trust and the resulting
termination of X’s S corporation election. 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.

                                  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 the year.

       Section 1361(b)(1)(B) 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, (2) 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, (3) have a nonresident alien as a shareholder, and (4) have more than one
class of stock.

       Section 1361(c)(2)(A)(iii) provides that for purposes of § 1361(b)(1)(B), a trust
with respect to stock transferred to it pursuant to the terms of a will is a permitted S
corporation shareholder, but only for the 2-year period beginning on the day on which
such stock is transferred to it.

       Section 1361(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B), an ESBT
is a permissible 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)-(5), or (IV) an organization
described in § 170(c)(1) which holds a contingent interest in such trust and is not a
PLR-113859-22                                 3

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 part, that
the trustee of an ESBT must make the ESBT election by signing and filing, with the
service center for which 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 ESBT election must be filed within
the time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a qualified subchapter S
trust election.

      Section 1362(a) 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(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)(A) is
effective on and after the date of cessation.

       Section 1362(f) provides, in part, that if (1) an election under § 1362(a) or
§ 1361(b)(3)(B)(ii) 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 (B) was terminated under § 1362(d)(2) or (3) or
§ 1361(b)(3)(C), (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 so that the corporation for which the election was made or the
termination occurred is a small business corporation or a qualified subchapter S
subsidiary (“QSub”), as the case may be, and (4) the corporation for which the election
was made or the termination occurred, 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 or a QSub, as the case may be) as may be required by the Secretary with
respect to such period, then, notwithstanding the circumstances resulting in the
ineffectiveness or termination, the corporation will be treated as an S corporation or a
PLR-113859-22                                 4

QSub, as the case may be, during the period specified by the Secretary.

                                      CONCLUSION

       Based on the representations made and information submitted, we conclude that
X’s S corporation election terminated on Date 4 when the trustees of Trust failed to file
an ESBT election for Trust. 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, under § 1362(f), X will be treated as continuing to be an S
corporation from Date 4 and thereafter, provided X’s S corporation election was valid
and not otherwise terminated under § 1362(d).

        This ruling is contingent on (1) Trust filing returns, including amended returns, for
all open years consistent with the requested relief within 120 days from the date of the
letter, and (2) the trustees of Trust filing an ESBT election for Trust effective Date 4 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 as specifically ruled upon above, we express or imply no opinion
concerning the federal tax consequences of the facts described above under any other
provision of the Code. Specifically, we express or imply no opinion on whether X was
eligible to be an S corporation or Trust was eligible 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 that requested it. Section 6110(k)(3)
of the Code provides that this ruling may not be used or cited as precedent.
PLR-113859-22                                 5

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


                                                  Sincerely,




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




Enclosure:
      Copy of this letter for § 6110 purposes


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