Missed trust election caused an inadvertent S corporation termination

Plain-English summary

An estate transferred S corporation stock to a trust under a will. The trust was an eligible shareholder for two years after the transfer, and it met the requirements for electing small business trust status after that period ended. Its trustees did not timely make the ESBT election, causing the corporation's S election to terminate. The IRS found the termination inadvertent and allowed S status to continue. Relief was conditioned on the trustee filing the ESBT election and the trust and beneficiaries filing consistent amended returns for all open years within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after a testamentary trust missed its ESBT election when its two-year shareholder eligibility ended?
• Outcome: Approved as an inadvertent termination, subject to election and amended-return conditions within 120 days
• Key authorities: IRC §§ 1361(c)(2), 1361(e), and 1362(f); Treas. Reg. § 1.1361-1

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202340005
Third Party Communication: None
Release Date: 10/6/2023
Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.00-00,
1361.03-00, 1361.03-03,
Person To Contact:
1362.00-00
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Telephone Number:
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Refer Reply To:
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PLR-100796-23
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Date:
July 11, 2023

Legend

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

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

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

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

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

State = --------

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

This letter responds to a letter dated December 27, 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).

FACTS

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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 1. A, who owned shares of X stock, died on Date 2. On Date 3, A’s estate transferred shares of X stock to Trust pursuant to the terms of A’s will. Trust qualified as an eligible S corporation shareholder for the two-year period beginning on the day the shares of X stock were transferred to it and ending Date 4 under § 1361(c)(2)(A)(iii).

X represents that beginning on Date 4, Trust met the requirements of an Electing Small Business Trust (ESBT) within the meaning of § 1361(e)(1)(A). 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 4.

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 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) provides that the term “small business corporation” means 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)(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 may be a 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 potential current

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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 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 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 or was terminated under § 1362(d)(2), (2) the Secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of time after discovery of the circumstances resulting in such 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 to acquire the required shareholder consents, and (4) the corporation for which the election was made or 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 ineffectiveness or 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 representations made, we conclude that X's S corporation election terminated on Date 4, because no ESBT election was filed for Trust. We further conclude that the termination of X's S corporation election on Date 4

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was inadvertent within the meaning of § 1362(f). Accordingly, X will be treated as an S corporation effective Date 4, and thereafter, provided that X's S corporation election was otherwise valid and was not otherwise terminated under § 1362(d).

This ruling in contingent upon the trustee of Trust filing an appropriately completed ESBT election for Trust effective on Date 4, and upon Trust and its beneficiaries filing timely amended federal income tax returns for all open years consistent with the treatment of Trust as an ESBT effective Date 4. The election must be made and the amended returns must be timely filed with the appropriate service center within 120 days following the date of this letter, and a copy of this letter should be attached to the returns. If these conditions are not met, this ruling is null and void.

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.

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 X's authorized representative.

Sincerely,

_______
Joy Spies, Senior Technician Reviewer
Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosure:
Copy for § 6110 purposes

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