S corporation receives relief for two missed ESBT elections

Plain-English summary

Three shareholder trusts initially qualified to hold S corporation stock under the grantor-trust rules. After their terms changed, all three were eligible to become electing small business trusts, but only one trust made a timely ESBT election. The other two trusts' missed elections terminated the corporation's S status. The corporation represented that the error did not involve tax avoidance or retroactive tax planning and that the affected returns consistently treated it as an S corporation. The IRS found the termination inadvertent and allowed S status to continue, provided the two trustees file ESBT elections within 120 days.

Ruling snapshot

• Question: May the corporation retain S status after two shareholder trusts failed to make timely ESBT elections?
• Outcome: Approved, conditioned on both trusts filing ESBT elections within 120 days
• Key authorities: IRC §§ 1361, 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: 202447011 Third Party Communication: None
Release Date: 11/22/2024 Date of Communication: Not Applicable
Index Numbers: 1361.03-03, 1362.04-00
Person To Contact:
----------------------------- ----------------------, ID No. -----------------
------------------------------------------------------------ Telephone Number:
------------------- --------------------
------------------- Refer Reply To:
------------------------- CC:PSI:B3
------------------------------------ PLR-104166-24
Date:
August 23, 2024

                                                 Legend

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

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

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

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

Trust 3 = ----------------------------------------------------------------------------------------------

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

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

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

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

n = ---
PLR-104166-24 2

m = ---

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

   This letter is in response to a letter dated November 30, 2023, 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

   The information submitted states that X was incorporated under the laws of State

on Date 1 and elected to be an S corporation effective Date 1. On Date 1, A, an
individual, was the sole shareholder of X.

   On Date 2, A transferred shares of X stock to Trust 1. Pursuant to the terms of

Trust 1, Trust 2 and Trust 3 were established as subtrusts of Trust 1 and were allocated
n% and m%, respectively, of all property assigned, conveyed, transferred and delivered
to Trust 1. X represents that Trust 1, Trust 2, and Trust 3 were all eligible S corporation
shareholders under § 1361(c)(2)(A)(i).

    On Date 3, the terms of Trust 1 were amended, thereby causing Trust 1, Trust 2,

and Trust 3 to no longer qualify as eligible S corporation shareholders under
§ 1361(c)(2)(A)(i). X represents that beginning on Date 3, Trust 1, Trust 2, and Trust 3
were eligible to be electing small business trusts (ESBTs) within the meaning of
§ 1361(e)(1). The trustee(s) of Trust 1 made a timely election under § 1361(e)(3) to
treat Trust 1 as an ESBT effective Date 3. However, the trustee(s) of Trust 2 and Trust
3 failed to make elections under § 1361(e)(3) treating Trust 2 and Trust 3 as ESBTs
effective Date 3. Consequently, X’s S corporation election terminated on Date 3.

    X represents that the circumstances resulting in the termination of its S

corporation election were not motivated by tax avoidance or retroactive tax planning.
Additionally, X represents that it and its shareholders (including Trust 2 and Trust 3)
have filed federal income tax returns consistent with X being treated as an S corporation
effective Date 1. Finally, X and its shareholders agree to make any adjustments
required as a condition of obtaining relief 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.
PLR-104166-24 3

   Section 1361(b)(1)(B) provides that the term “small business corporation” means

a domestic corporation which is not an ineligible corporation and which does not, among
other requirements, 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.
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) 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)(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, 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 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) 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 for which 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 qualified subchapter S
trust election.

  Section 1362(a) provides that, except as provided in § 1362(g), a small business

corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

    Section 1362(d)(2)(A) provides that an election under § 1362(a) is 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.
PLR-104166-24 4

    Section 1362(f) provides, in part, that if (1) an election under § 1362(a) by any

corporation (A) 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 (B) 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, and (4) the corporation for which the election was made or the termination
occurred, 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 may be required by the
Secretary with respect to such period, then, notwithstanding the circumstances resulting
in such ineffectiveness or 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 X’s S corporation election terminated on Date 3 when Trust 2 and Trust 3 became
ineligible S corporation shareholders under § 1361(b)(1)(B). We further conclude that
the circumstances resulting in the termination of X’s S corporation election were
inadvertent within the meaning of § 1362(f). Accordingly, 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(s) of each of Trust 2 and Trust 3 filing an

ESBT election for Trust 2 and Trust 3, respectively, 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 each ESBT election.

     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 and Trust 1’s, Trust 2’s, and Trust 3’s eligibility to be
ESBTs.

   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 requesting it. Section 6110(k)(3) of

the Code provides that they may not be used or cited as precedent.
PLR-104166-24 5

  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

cc: -----------------------

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