Inadvertent S-corp termination relief after trust missed its ESBT election

Plain-English summary

A corporation was taxed as an S corporation, which passes its income through to
shareholders instead of paying corporate-level tax. S corporations may only have
certain kinds of shareholders. When the company's stock was transferred to a
trust, the trust could have qualified as an "electing small business trust"
(ESBT), a permitted S-corporation shareholder, but the trustees never filed the
ESBT election on time. That failure automatically terminated the company's S
election as of the transfer date. The company asked the IRS to treat the
termination as inadvertent under Code § 1362(f). The IRS agreed, finding no tax
avoidance and good faith. It restored the company's S status back to the transfer
date, on the condition that the trustee file the ESBT election within 120 days
and the company make a required payment. This matters because a paperwork slip on
a trust election can accidentally end S-corporation status, and § 1362(f) lets
the IRS undo that when the mistake was innocent.

Ruling snapshot

• Question: Was the termination of a company's S election, caused by a trust's failure to file a timely ESBT election, inadvertent so that S status can be restored?
• Outcome: approved (inadvertent termination relief granted, subject to conditions)
• Key authorities: IRC § 1362(f); IRC § 1361(e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202319004                                             Third Party Communication: None
 Release Date: 5/12/2023                                       Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                               Person To Contact:
 ----------------------------------                            --------------------, ID No. -----------------
 -------------------------------------------------             Telephone Number:
 -----------------------------                                 --------------------
 --------------------------------                              Refer Reply To:
 ----------------------------                                  CC:PSI:B03
                                                               PLR-115499-22
                                                               Date:
                                                               February 01, 2023




LEGEND:

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

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

State                     =        --------

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

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

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

N                         =        ------------


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

       This letter responds to a letter dated August 1, 2022, and subsequent
correspondence, submitted on behalf of X by its authorized representatives requesting a
ruling under § 1362(f) of the Internal Revenue Code (Code).
PLR-115499-22                                2

                                          FACTS

       The information submitted states that X was incorporated on Date 1 under the
laws of State. X elected to be an S corporation effective Date 2. On Date 3, X stock
was transferred to Trust. As of Date 3, Trust was eligible to elect to be treated as an
Electing Small Business Trust (ESBT) within the meaning of § 1361(e)(3). However,
the trustees of Trust did not make a timely election for Trust to be treated as an ESBT
under § 1361(e)(3), thus causing X’s S corporation election to terminate effective
Date 3.

        X represents that there was no tax avoidance or retroactive tax planning involved
in the failure of Trust to file an ESBT election and the resulting termination of X’s S
corporation election. X and its shareholders agree to make any adjustments required
as a condition of obtaining relief under the inadvertent termination rule as provided
under § 1362(f) of the Code that may be required by the Secretary.

                                           LAW

        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”, in part, as 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)(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
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) provides, in part, that the trustee of an ESBT must
make the ESBT election by signing and filing, with the service center where the S
PLR-115499-22                                3

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 QSST election.

       Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be
terminated whenever (at any time on or after the 1st day of the 1st 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 relevant part, that if (1) an election under § 1362(a)
by any corporation was terminated under § 1362(d)(2) or (3) or § 1361(b)(3)(C), (2) the
Secretary determines that the circumstances resulting in the termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in the 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 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 termination, the corporation will be
treated as an S corporation during the period specified by the Secretary.

                                      CONCLUSION

       Based solely on the facts submitted and representations made, we conclude that
X’s S corporation election terminated on Date 3, because no ESBT election was filed for
Trust. We further conclude that the termination of X’s S corporation election on Date 3,
was inadvertent within the meaning of § 1362(f). Accordingly, X will be treated as an S
corporation effective Date 3, and thereafter, provided that X’s S corporation election
was otherwise valid and was not otherwise terminated under § 1362(d).

       This letter ruling, is subject to the following must be filed with the appropriate
service center within 120 days from the date of this letter the trustee of Trust must file
an ESBT effective Date 3. A copy of this letter must be attached to the ESBT election.

         Furthermore, as an adjustment under § 1362(f)(4), a payment of $N and a copy
of this letter must be sent to the following address within 45 days from the date of this
letter: Internal Revenue Service, Kansas City Submission Processing Campus, 333 W.
Pershing Road, Kansas City, MO 64108, Stop 7777, Attn: Manual Deposit.
PLR-115499-22                                 4

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 where X’s S corporation
election is filed that its S corporation election has terminated effective Date 3.

         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’s eligibility 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 this ruling may not be used or cited as precedent.

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


                                                  Sincerely,




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




Enclosure:
      Copy for § 6110 purposes


cc: