Missing ESBT election caused an inadvertent S corporation termination

Plain-English summary

An individual held S corporation stock through an eligible trust and later died. After the original trust elected to be included in the estate, it distributed the S corporation stock to a second trust. The second trust met the substantive requirements for an electing small business trust (ESBT), but its trustee did not timely make the ESBT election. That made the trust an ineligible shareholder and terminated the corporation's S election on the transfer date. The corporation represented that the lapse was inadvertent, was not tax-motivated, and that it and its shareholders continued filing consistently with S corporation status. The IRS treated the termination as inadvertent and allowed uninterrupted S corporation treatment, conditioned on the trustee filing an ESBT election effective on the transfer date within 120 days. The ruling did not decide whether the corporation or either trust otherwise met the applicable eligibility rules.

Ruling snapshot

• Question: Was the S corporation's termination inadvertent when a successor trust failed to timely elect ESBT status?
• Outcome: approved (continuous S corporation treatment, contingent on a retroactive ESBT election filed within 120 days)
• Key authorities: IRC §§ 1361(c), 1361(e), 1362(d), 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

  Internal Revenue Service                                       Department of the Treasury
                                                                 Washington, DC 20224

  Number: 202448001                                              Third Party Communication: None
  Release Date: 11/29/2024                                       Date of Communication: Not Applicable
  Index Number: 1362.04-00
                                                                 Person To Contact:
  ----------------------                                         -------------------------, ID No. -----------------
  --------------------------------------------------             Telephone Number:
  ---------------------------------------------                  --------------------
  -------------------------                                      Refer Reply To:
  ---------------------------------                              CC:PSI:B03
                                                                 PLR-100912-24
                                                                 Date:
                                                                 June 15, 2024




Legend
X             =             ----------------------
                            -----------------------

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

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

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

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

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

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

Date 4        =             -------------------------

State         =             ---------

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

      This letter responds to a letter dated December 27, 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).

PLR-100912-24                                 2

                                          FACTS

      The information submitted states that X was incorporated on Date 1 under the laws
of State. X elected to be an S corporation effective Date 2. A, an individual, owned shares
of X stock through Trust 1. Trust 1 was an eligible S corporation shareholder
under § 1361(c)(2)(A)(i). On Date 3, A died. After A's death, Trust 1 elected under § 645 to
be included in A's estate. On Date 4, pursuant to the terms of Trust 1, the assets of
Trust 1, including the stock of X, were distributed to Trust 2.

      X represents that beginning on Date 4, Trust 2 met the requirements of an Electing
Small Business Trust (ESBT) within the meaning of § 1361(e)(1)(A). However, the trustee
of Trust 2 did not make a timely election for Trust 2 to be treated as an ESBT
under § 1361(e)(3) in order for it to be an eligible S corporation shareholder of X. Thus,
Trust 2 was an ineligible shareholder of X on Date 4, thus causing X's S corporation
election to terminate on Date 4.

      X represents that 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. X represents that X and its shareholders have filed all returns
consistent with X’s status as an S corporation. X and its shareholders agree to make any
adjustments required as a condition of obtaining relief under the inadvertent termination
rule as provided under § 1362(f) of the Code that may be required by the Secretary.

                                   LAW AND ANALYSIS

     Section 1361(a)(1) of the Code 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 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)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust with
respect to stock transferred to it pursuant to the terms of a will may be a shareholder, but
only for the 2-year period beginning on the day on which such stock is transferred to it.

     Section 1361(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B), an ESBT is
a permissible 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

PLR-100912-24                                   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)(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
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 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 ESBT election must be filed within the
time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a QSST election.

     Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 1st 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 to
obtain shareholder consents or 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 or to acquire the required shareholder consents, 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.

PLR-100912-24                                   4

                                        CONCLUSION

      Based solely on the facts submitted and representations made, we conclude
that X's S corporation election terminated on Date 4, because no ESBT election was filed
for Trust 2. We further conclude that the termination of X's S corporation election
on Date 4 was inadvertent within the meaning of § 1362(f). Accordingly, X will be treated
as an S corporation effective Date 4 and thereafter, provided that X's S corporation
election was otherwise valid and was not otherwise terminated under § 1362(d).

       This ruling in contingent upon the trustee of Trust 2 filing an appropriately
completed ESBT election for Trust 2 effective on Date 4. The election must be made with
the appropriate service center within one hundred-twenty (120) days following the date of
this letter, and a copy of this letter should be attached to the returns. If these conditions
are not met, this ruling is null and void.

      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, Trust 1’s eligibility as an S corporation shareholder, or Trust 2's eligibility to be
an ESBT.

     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.

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


                                         Sincerely,



                                         Robert D. Alinsky
                                         Branch Chief, Branch 3
                                         Office of the Associate Chief Counsel
                                         (Passthroughs & Special Industries)

PLR-100912-24                                           5


Enclosure:
     Copy of this letter for § 6110 purposes

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