S election restored after two missed ESBT elections

Plain-English summary

An S corporation transferred ownership interests to two trusts, but their trustees did not timely elect to treat the trusts as electing small business trusts. Those failures caused the corporation's S election to terminate when each trust became an owner. The corporation represented that both trusts otherwise qualified as ESBTs, the failures were inadvertent, and all returns had consistently treated the corporation as an S corporation. The IRS restored S status, conditioned on both trustees filing retroactive ESBT elections and any required amended returns within 120 days. The corporation also had to make a specified payment by the redacted deadline, or the ruling would become void.

Ruling snapshot

• Question: Was the S election's termination from two untimely 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: 202403002                                              Third Party Communication: None
 Release Date: 1/19/2024                                        Date of Communication: Not Applicable
 Index Number: 1362.00-00, 1362.02-00,
               1362.04-00                                       Person To Contact:
                                                                ------------------------, ID No. -----------------
 ----------------------                                         Telephone Number:
 -----------------------------------------                      --------------------
 -------------------------------                                Refer Reply To:
 -------------------------------------                          CC:PSI:B01
 ------------------------------                                 PLR-107670-23
                                                                Date:
                                                                October 06, 2023




                                                   LEGEND

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

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

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

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

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

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

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

 Date 4              -------------------------

 Date 5              --------------------------

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


Dear ----------------:

PLR-107670-23                                 2

This letter responds to a letter dated April 4, 2023, and subsequent correspondence,
submitted on behalf of X by X’s authorized representatives, requesting a ruling under
§ 1362(f) of the Internal Revenue Code (Code).

                                          FACTS

According to the information submitted and representations made, X, organized under
the laws of State on Date 1, made an election to be treated as an S corporation
effective on Date 2. On Date 3, membership interests in X were transferred to Trust 1.
On Date 4, membership interests in X were transferred to Trust 2. Trustees of Trust 1
and Trust 2 did not make timely elections for Trust 1 and Trust 2 to be treated as an
electing small business trust (ESBT) under § 1361(e)(3), thus causing X’s S election to
terminate effective Date 3 and Date 4.

X represents that Trust 1 and Trust 2 have at all times met the requirements of an ESBT
within the meaning of § 1361(e), except that the trustees of Trust 1 and Trust 2 did not
make a timely ESBT election under § 1361(e)(3). X further represents that the
circumstances resulting in the termination of X’s S corporation election were inadvertent
and were not motivated by tax avoidance or retroactive tax planning. Additionally, X
represents that X and its shareholders have filed income tax returns consistent with
having a valid S election in effect for all taxable years since its election on Date 2. X
and X’s shareholders from Date 3 and thereafter consent to make any adjustments
consistent with the treatment of X 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

PLR-107670-23                                 3

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
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, 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 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, in part, 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 with respect to 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

PLR-107670-23                                  4

X’s S corporation election terminated on Date 3 and Date 4 when the trustees of Trust 1
and Trust 2 failed to make elections under section § 1362(e)(3) to treat Trust 1 and
Trust 2 as ESBTs effective Date 3 and Date 4. We further conclude that the termination
of X’s S election was inadvertent within the meaning of § 1362(f). Therefore, pursuant
to the provisions of § 1362(f), X will be treated as an S corporation effective Date 3 and
thereafter, provided X’s S corporation 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 an election to treat Trust 1 and Trust 2 as ESBTs, effective
Date 3 and Date 4, respectively, 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 the trusts as ESBTs for all open 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 5.

If the conditions are not met, this ruling is null and void. In addition, if these conditions
are not met, X must notify the service center with which it filed its S corporation election
that its election terminated on Date 3.

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 X's eligibility to be an S
corporation or Trust 1 and Trust 2‘s eligibility 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-107670-23                                     5

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to X's authorized representatives.

                                            Sincerely,



                                            _______________________________
                                            Caroline E. Hay
                                            Senior Technician Reviewer, Branch 1
                                            Office of the Associate Chief Counsel
                                            (Passthroughs & Special Industries)

Enclosure

        Copy for § 6110 purposes


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