S election restored after inherited shares entered two trusts

Plain-English summary

Two trusts acquired shares in an S corporation under a will, but their trustees did not timely elect to treat them as electing small business trusts. The missed elections caused the corporation's S election to terminate on the transfer date. The corporation represented that the trusts otherwise qualified as ESBTs and that all returns had consistently treated the S election as valid. The IRS found the termination inadvertent and restored S status. Relief was conditioned on both trusts filing retroactive ESBT elections and amended returns within 120 days, along with a specified payment by the redacted deadline.

Ruling snapshot

• Question: Was the S election's termination after two trusts inherited shares without timely ESBT elections inadvertent and eligible for relief?
• Outcome: approved
• Key authorities: IRC §§ 1361, 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

 Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202403001                                            Third Party Communication: None
 Release Date: 1/19/2024                                      Date of Communication: Not Applicable
 Index Number: 1362.04-00
                                                              Person To Contact:
 --------------------------------                             ------------, ID No. -----------------
 ----------------------------------------------               Telephone Number:
 ----------------------------                                 --------------------
 -------------------------                                    Refer Reply To:
 -------------------------                                    CC:PSI:B03
                                                              PLR-106743-23
                                                              Date:
                                                              September 25, 2023




LEGEND

 Company = ----------------------------------------------------------------------------------------------
           ----------------------

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

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

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

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

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

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

 $n             = ---------------


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

      This letter responds to a letter dated March 6, 2023, 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-106743-23                                 2

                                          FACTS

      According to the information submitted and representations made, Company,
organized under the laws of State, elected to be an S corporation effective Date 1. On
Date 2, Trust 1 and Trust 2 acquired shares in Company pursuant to the terms of a will.
However, a timely Electing Small Business Trust (ESBT) election under § 1362(e) was
not made for Trust 1 or Trust 2. Consequently, Company’s S corporation election
terminated, effective Date 2.

       Company represents that Trust 1 and Trust 2 has at all times since Date 2 met
the requirements of an Electing Small Business Trust (ESBT) within the meaning of
§ 1361(e), except that the trustees of Trust 1 and Trust 2 did not make timely ESBT
elections under § 1362(e) effective Date 2. Company represents that Trust 1 and
Trust 2 will file to elect to be treated as an ESBT under § 1361(e)(3) if a ruling request is
granted. Company further represents that it has filed income tax returns consistent with
having a valid S election in effect for all taxable years since its election on Date 1.
Company and Company’s shareholders from Date 2 and thereafter consent to make
any adjustments consistent with the treatment of Company as an S corporation as may
be required by the Commissioner.

                                  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) provides that the term “small business corporation” means a
domestic corporation that is not an ineligible corporation and 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 1
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.

       Section 1361(e)(1)(B) provides that an ESBT does not include (i) any qualified
subchapter S trust (as defined in § 1361(d)(3)) if an election under § 1361(d)(2) applies
to any corporation the stock of which is held by such trust, (ii) any trust exempt from tax

PLR-106743-23                                 3

under subtitle A, and (iii) any charitable remainder annuity trust or charitable remainder
unitrust (as defined in § 664(d)).

       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
QSST election (generally within the 16-day-and-2-month period beginning on the day
that the stock is transferred to the trust).

        Section 1362(d)(2) 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. A termination of an S corporation election under § 1362(d)(2) shall be
effective on and after the date of cessation.

        Section 1362(f) provides that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that
the circumstances resulting in termination were inadvertent; (3) no later than a
reasonable period of time after discovery of the circumstances resulting in termination,
steps were taken so that the corporation is a small business corporation, and (4) the
corporation, and each person who was a shareholder of the corporation at any time
during the period specified pursuant to § 1362(f), agrees to make the adjustments
(consistent with the treatment of the corporation as an S corporation) as might be
required by the Secretary regarding this period, then, notwithstanding the circumstances
resulting in termination, the 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 2 when the trustees of
Trust 1 and Trust 2 failed to make elections under § 1362(e)(3) to treat Trust 1 and
Trust 2 as ESBTs effective Date 2. We further conclude that the termination of
Company’s S election was inadvertent within the meaning of § 1362(f). Therefore,
pursuant to the provisions of § 1362(f), Company will be treated as an S corporation

PLR-106743-23                                 4

effective Date 2 and thereafter, provided Company’s S election is otherwise valid and
not otherwise terminated under § 1362(d).

         This letter is contingent on the following: within 120 days of this letter (1) the
trustees of Trust 1 and Trust 2 filing ESBT elections effective Date 2 with the
appropriate service center, and (2) Trust 1 and Trust 2 filing any amended returns and
making adjustments to properly reflect the treatment of Trust 1 and Trust 2 as ESBTs
for all relevant taxable years. A copy of this letter should be attached to any elections or
returns.

        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:

                            Internal Revenue Service
                            Kansas City Service Center
                            333 W. Pershing Road
                            Kansas City, MO 64108
                            Stop 7777
                            Attn: Manual Deposit

       This payment and a copy of this letter must be sent no later than Date 3.

       If the conditions are not met, this ruling is null and void. In addition, if these
conditions are not met, Company must notify the service center with which it filed its S
corporation election that its election terminated on Date 2.

       Except as specifically set forth 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 regarding Company's eligibility to
be an S corporation, or the eligibility of Trust 1 or Trust 2 to elect to be treated as an
ESBT.

      The ruling contained in this letter are 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 request for rulings, it is subject to verification on
examination.

      This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

PLR-106743-23                                          5

         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to Company’s authorized representative.


                                                 Sincerely,



                                                     /S/
                                                 _____________________________
                                                 Richard T. Probst
                                                 Senior Technician Reviewer, Branch 3
                                                 (Passthroughs & Special Industries)



Enclosure:
      Copy of this letter for § 6100 purposes



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