S corporation election restored after a grantor trust missed its ESBT election

Plain-English summary

A corporation was taxed as an S corporation, and one of its shareholders was a grantor trust treated as owned by an individual, which is a permitted S corporation shareholder. When that individual died, the trust could remain a permitted shareholder for only two years unless it made an "electing small business trust" (ESBT) election. The trustee missed that election deadline, which automatically terminated the company's S corporation status. Under Section 1362(f), the IRS can excuse an inadvertent termination if it was not driven by tax avoidance, is corrected within a reasonable time, and everyone agrees to make consistent adjustments. The IRS found the termination inadvertent and ruled that the company continues to be treated as an S corporation, provided the trustee files the ESBT election within 120 days and the company sends a specified payment within 45 days. (This ruling is a companion to PLRs 202438008 through 202438011, issued the same day on the same facts.)

Ruling snapshot

• Question: Was the termination of the corporation's S election (caused by a trust missing its ESBT election after the deemed owner's death) inadvertent under § 1362(f)?
• Outcome: approved (inadvertent-termination relief granted, conditioned on a late ESBT election and a payment)
• Key authorities: IRC §§ 1361(b), (c)(2), (e); 1362(a), (d)(2), (f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 202438007
Third Party Communication: None
Release Date: 9/20/2024
Date of Communication: Not Applicable
Index Numbers: 1361.01-02, 1361.03-03,
1362.00-00, 1362.02-02,
Person To Contact:
1362.04-00
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Telephone Number:
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Refer Reply To:
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CC:PSI:B03
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PLR-113229-23

Date:
June 04, 2024

LEGEND

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

A = ----------------------

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

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

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

n = ---------

Dear ---------------

This letter responds to a letter dated May 24, 2023, and subsequent correspondence submitted on behalf of X by its authorized representative, requesting a ruling under § 1362(f) of the Internal Revenue Code (Code).

FACTS

According to the information submitted and representations made, X, a State corporation, elected to be an S corporation effective Date 1. Trust owned shares of X stock. X represents that Trust was treated under subpart E of part I of subchapter J of chapter 1 of the Code as entirely owned by A and, thus, was an eligible S corporation shareholder under § 1361(c)(2)(A)(i). On Date 2, A died. Trust continued to be an eligible S corporation shareholder under § 1361(c)(2)(A)(ii) for a 2-year period beginning on Date 2. X represents that Trust was eligible to be an electing small business trust (ESBT) under § 1361(e)(1) effective Date 3. However, the trustee of Trust failed to make an election under § 1361(e)(3) treating Trust as an ESBT effective Date 3. Therefore, X's S corporation election terminated on Date 3.

X represents that the circumstances resulting in the termination of its S corporation election were inadvertent and not motivated by tax avoidance or retroactive tax planning. 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 under § 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)(i) provides that, for purposes of § 1361(b)(1)(B), a trust all of which is treated (under subpart E of part I of subchapter J of chapter 1 of the Code) as owned by an individual who is a citizen or resident of the United States may be an S corporation shareholder.

Section 1361(c)(2)(A)(ii) provides that, for purposes of § 1361(b)(1)(B), a trust which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed owner and which continues in existence after such death, may be an S corporation shareholder, but only for the 2-year period beginning on the day of the deemed owner's death.

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)(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) provides, in part, that the trustee of an ESBT must make the ESBT election by signing and filing, with the service center for which the S corporation files its income tax return, a statement that meets the requirements of § 1.1361-1(m)(2)(ii). Generally, only one ESBT election is made for the trust, regardless of the number of S corporations whose stock is held by the ESBT.

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

Section 1362(a) provides that a small business corporation may elect to be an S corporation.

Section 1362(d)(2) provides that an S corporation election will 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)(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 was terminated under § 1362(d)(2) or (3); (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; 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 3 when X had an ineligible S corporation shareholder under § 1361(b)(1)(B). We also conclude that the circumstances resulting in the termination of X's S corporation election were inadvertent within the meaning of § 1362(f). Therefore, under § 1362(f), X will continue to be treated as an S corporation from Date 3 and thereafter, provided that X's S corporation election was valid and has not otherwise terminated under § 1362(d).

This ruling is conditioned on the trustee of Trust filing an ESBT election for Trust effective Date 3 with the appropriate service center within 120 days from the date of this letter. A copy of this letter should be attached to the ESBT election.

Also, as an adjustment under § 1362(f)(4), X must send a payment of $n, with a copy of this letter within 45 days from the date of this letter to the following address:

Internal Revenue Service
Kansas City Submission Processing Campus 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 3.

Except as specifically ruled on 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 and 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 requested ruling, 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.

In accordance with 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:
Copy of this letter for § 6110 purposes

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