Late ESBT election did not end the corporation's S status

Plain-English summary

A trust eligible to be an electing small business trust acquired all shares of an S corporation, but its trustees did not timely file the ESBT election, technically terminating the corporation's S election. The corporation had continued filing as an S corporation and represented that the lapse was not motivated by tax avoidance or retroactive planning. The IRS found the termination inadvertent and allowed S status to continue. The relief requires the trustees to file the ESBT election and required trust returns within 120 days, and also requires a specified payment by the stated deadline. Failure to meet those conditions makes the ruling null and void.

Ruling snapshot

• Question: Could the corporation retain S status despite the trust's late ESBT election?
• Outcome: Approved as an inadvertent termination, subject to election, return-filing, and payment conditions
• Key authorities: IRC §§ 1361(e) 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: 202408001
Third Party Communication: None
Release Date: 2/23/2024
Date of Communication: Not Applicable
Index Numbers: 1361.03-03, 1362.00-00,
1362.04-00
Person To Contact:
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Refer Reply To:
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CC:PSI:B3
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PLR-110118-23
Date:
November 9, 2023

LEGEND

X = ----------------------------------------------
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Trust = ----------------------------------------------
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State = ------------------

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

Date 2 = ----------------------------------------------
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Date 3 = ----------------------------------------------
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Years = --------------------

n = ---------
2
PLR-110118-23

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

This letter responds to a letter dated May 4, 2023, and subsequent correspondence, submitted on behalf of X, requesting a ruling under § 1362(f) of the Internal Revenue Code (“Code”).

FACTS

X was incorporated under the laws of State on Date 1 and elected to be an S corporation effective Date 1. On Date 2, Trust acquired all the outstanding shares of X stock. Trust was eligible to be an electing small business trust (“ESBT”) under § 1361(e)(1), but the trustees of Trust did not timely file an ESBT election under § 1361(e)(3). As a result, X’s S corporation election terminated on Date 2.

X represents that the circumstances resulting in the termination of its S corporation election were not motivated by tax avoidance or retroactive tax planning. Further, X represents that it has filed consistently with being an S corporation since Date 1. Finally, 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 with respect to the period specified by § 1362(f).

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) 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, (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)(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, 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
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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 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 relevant 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 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) shall be 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); (2) the Secretary determines that the circumstances resulting in such termination were inadvertent; (3) no later than a reasonable period of time after discovery of the circumstances resulting in such 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 in 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 may be required by the Secretary with respect to such period, then, notwithstanding the circumstances resulting in the 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 representations made, we conclude that X’s S corporation election terminated on Date 2 when Trust, an ineligible S corporation shareholder, acquired shares of X stock. We further conclude that the circumstances resulting in the termination were inadvertent within the meaning of § 1362(f). Accordingly, pursuant to the provisions of § 1362(f), X will continue to be treated as an S corporation from Date 2 and thereafter, provided that X’s S corporation election was valid and has not otherwise terminated under § 1362(d).

This ruling is contingent on (1) the trustees of Trust filing an ESBT election for Trust effective Date 2 with the appropriate service center within 120 days from the date of this letter, and (2) Trust filing returns, including amended returns, for Years with the
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appropriate service center within 120 days from the date of this letter to properly reflect the treatment of Trust as an ESBT effective Date 2. A copy of this letter should be attached to the ESBT election and the returns.

Additionally, as an adjustment under § 1362(f)(4), a payment of $n and a copy of this letter ruling must be sent no later than Date 3 to the following address:

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

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 with which it filed its S corporation election that its election terminated on Date 2.

Except for the specific ruling 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 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 requested ruling, it is subject to verification on examination.

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.

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

Sincerely,

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

Enclosure:
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A copy of this letter for § 6110 purposes

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