A trust holding S corporation stock under a will missed its election deadline, and the IRS restores the company's S status

Plain-English summary

A shareholder of an S corporation died, and the S corporation stock passed through the shareholder's estate into a trust set up by the will. A trust that receives S corporation stock under a will can hold it for two years without any special election, but to keep the stock after that the trustee had to elect to treat the trust as an Electing Small Business Trust (ESBT). The trustee never filed that election, so when the two-year window closed the trust became an ineligible shareholder and the company's S corporation status automatically ended. The company asked the IRS to treat the lapse as an inadvertent termination under Code section 1362(f). The IRS agreed the failure was inadvertent and granted relief: the company is treated as having remained an S corporation, provided the trustee files the ESBT election and everyone files consistent returns within 120 days. This is the routine cure for a missed trust election that would otherwise cost a business its pass-through tax treatment.

Ruling snapshot

• Question: Was the termination of the company's S corporation election, caused by the trustee's failure to file an ESBT election after the two-year post-transfer window, inadvertent and eligible for relief under § 1362(f)?
• Outcome: Approved (relief granted, contingent on filing the ESBT election and consistent returns within 120 days)
• Key authorities: IRC §§ 1361(c)(2)(A)(iii), 1361(e), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202450003                                              Third Party Communication: None
Release Date: 12/13/2024                                       Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.01-02
                                                               Person To Contact:
---------------------------------------------------            ----------------------, ID No. -----------------
---------------------------                                    Telephone Number:
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----------------------------                                   Refer Reply To:
-----------------------------                                  CC:PSI:B01
                                                               PLR-105124-24
                                                               Date:
                                                               September 12, 2024




                                                      Legend

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

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

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

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

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

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

Trust 1       = ----------------------------------------------------------------------
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Trust 2       = ----------------------------------------------------------------------
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PLR-105124-24                                2

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

This responds to a letter dated January 30, 2024, and subsequent correspondence,
submitted on behalf of X by its authorized representatives, requesting a ruling under
§ 1362(f) of the Internal Revenue Code (the Code).

                                         FACTS

The information submitted states that X was incorporated under the laws of State on
Date 1. X filed an election in accordance with the provisions of § 1362(a) of the Code to
be taxed as an S corporation effective Date 2.

On Date 3, A died. Prior to A's death, shares of X had been owned by Trust 1. Trust 1
had been treated as owned by A and was therefore an eligible S corporation
shareholder under § 1361(c)(2)(A)(i). Following A's death, Trust 1 terminated, and the
shares of X held by Trust 1 were distributed to and made part of A's estate pursuant to
A's will. Pursuant to A's estate plan, shares of X held by A's estate were transferred to
Trust 2. Trust 2 qualified as an eligible S corporation shareholder under
§ 1361(c)(2)(A)(iii) for the two-year period beginning on the day the shares of X stock
were transferred to it and ending on Date 4.

Trust 2 continued to hold shares of X after Date 4. X represents that Trust 2 met the
requirements of an Electing Small Business Trust (ESBT) within the meaning of
§ 1361(e)(1)(A), except that the trustee of Trust 2 failed to file an election under
§ 1361(e)(3). Consequently, Trust 2 became an ineligible shareholder of X and X's S
corporation status terminated on Date 4.

X represents that the circumstances resulting in the termination of X's S corporation
election on Date 4 were not motived by tax avoidance. X further represents that for each
taxable year since X elected to be an S corporation, X and its shareholders have filed
their federal income tax returns consistent with X having a valid S corporation election
and Trust 2 having a valid ESBT election in effect. Further, X and its shareholders have
agreed 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

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)(B) provides that the term "small business corporation" means a
domestic corporation which is not an ineligible corporation and which does not 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.
PLR-105124-24                                 3


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)(iii) provides that for purposes of § 1361(b)(1)(B), a trust may be a
shareholder with respect to stock transferred to it pursuant to the terms of a will, 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
permitted shareholder of a small business corporation.

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) 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 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(d)(2) provides that (A) in general, 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, and (B) any termination 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 (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 to obtain shareholder consents or (B) was terminated under § 1362(d)(2)
PLR-105124-24                                   4

or (3), (2) the Secretary determines that the circumstances resulting in the
ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of
time after discovery of the circumstances resulting in the ineffectiveness or termination,
steps were taken (A) so that the corporation is a small business corporation or (B) to
acquire the shareholder consents, 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 such 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 ineffectiveness or
termination, the corporation will be treated as an S corporation during the period
specified by the Secretary.

                                        CONCLUSION

Based solely on the information submitted and the representations made, we conclude
that X's S corporation election terminated on Date 4 when Trust 2 became an ineligible
shareholder. 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,
pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation from Date 4 and thereafter, provided that X's S corporation election was
valid and was not otherwise terminated under § 1362(d) for reasons not addressed in
this letter.

This letter is subject to the following conditions, which must occur within 120 days from
the date of this letter: (1) the trustee(s) of Trust 2 must file an election to treat Trust 2 as
an ESBT effective Date 4 with the appropriate service center; and (2) X and each of its
shareholders must file any necessary original or amended returns for all open taxable
years consistent with the relief granted in this letter.

A copy of this letter should be attached to the ESBT election. Furthermore, if these
conditions are not met, X must notify the service center where X's S corporation election
is filed that its S corporation election has terminated effective Date 4.

Except as specifically set forth above, we express or imply no opinion concerning the
federal tax consequences of the transactions 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 the eligibility of Trust 2 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 ruling request, it is subject to verification on examination.
PLR-105124-24                                            5

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) provides
that it may not be used or cited as precedent. Pursuant to a power of attorney on file, a
copy of this letter is being sent to X's authorized representative.

                                                Sincerely,


                                                __________________________
                                                Joyce C. Spies
                                                Senior Technician Reviewer, Branch 1
                                                (Passthroughs & Special Industries)

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