Inadvertent-termination relief restoring a corporation's S election after trustees missed the ESBT elections

Plain-English summary

This letter fixes an accidental loss of S corporation status. An S corporation can only have certain kinds of shareholders; a trust generally has to make an "electing small business trust" (ESBT) election to qualify. Here, shareholders transferred their stock to two trusts that were eligible to be ESBTs, but the trustees never filed the ESBT elections. That made the trusts ineligible shareholders and automatically terminated the company's S election on the transfer date. The company and its shareholders had continued filing all returns as if it were still an S corporation, and the failure was inadvertent and not tax-motivated. Under Section 1362(f), the IRS can forgive an inadvertent termination, and it did so here: the company will be treated as remaining an S corporation, provided that within 120 days the trustees file the ESBT elections effective the transfer date and everyone files any needed returns consistent with the relief. If those conditions are not met, the ruling is void.

Ruling snapshot

• Question: Was the termination of the corporation's S election (caused by the trustees' failure to make timely ESBT elections) inadvertent, so that S status can be restored under IRC § 1362(f)?
• Outcome: approved (inadvertent-termination relief granted, subject to conditions)
• Key authorities: IRC § 1362(f); IRC §§ 1361(b), 1361(c)(2), 1361(e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 202503004                                            Third Party Communication: None
Release Date: 1/17/2025                                      Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                             Person To Contact:
-----------------------------------------                    -----------------------------------, ID No. -------
-----------------------------------------------              -----------------
-----------------------------                                Telephone Number:
---------------------------                                  --------------------
---------------------------                                  Refer Reply To:
                                                             CC:PSI:B03
                                                             PLR-107710-24

                                                             Date:
                                                             October 18, 2024


                                                  LEGEND

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

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

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

 B             = ----------------------------------
                 ------------------------

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

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

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

 Date 2        = --------------------------
PLR-107710-24                                2

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

       This responds to a letter dated April 4, 2024, submitted on behalf of X by X’s
authorized representatives, requesting relief under section 1362(f) of the Internal
Revenue Code.

                                         FACTS

       The information submitted states that X was incorporated under the laws of State
and elected to be treated as an S corporation effective Date 1. On Date 2, A and B
transferred shares of X to Trust 1 and Trust 2.

       It is represented that Trust 1 and Trust 2 were eligible to make Electing Small
Business Trust (ESBT) elections under § 1361(e)(3), effective Date 2. However, the
trustees of Trust 1 and Trust 2 failed to make ESBT elections for the trusts to be eligible
S corporation shareholders; thus, Trust 1 and Trust 2 became ineligible shareholders of
X on Date 2. Accordingly, the failure to make ESBT elections caused X’s S election to
terminate on Date 2.

        X and its shareholders have filed all income tax returns consistent with having an
election to be treated as an S corporation for all taxable years since its formation on
Date 1. Trust 1 and Trust 2 have always met the ESBT requirements within the
meaning of § 1361(e), except that the trustees did not make a timely ESBT election
under § 1361(e)(3). The failure to file ESBT elections was inadvertent and not
motivated by tax avoidance or retroactive tax planning. X and each of its shareholders
agree to make any adjustments required by the Secretary as a condition of obtaining
relief under the inadvertent termination rule as provided 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 1
class of stock.

       Section 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an electing
small business trust (ESBT) may be an S corporation shareholder.

        Section 1361(e)(1)(A) provides that an ESBT means any trust if (i) such trust does
PLR-107710-24                                 3

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)(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 QSST
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 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(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 termination occurred is a small business corporation;
and (4) the corporation for which the election was made or 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-107710-24                                  4

                                      CONCLUSION

       Based solely on the facts submitted and representations made, we conclude that
X’s S corporation election terminated on Date 2 because the trustees of Trust 1 and
Trust 2 failed to timely make ESBT elections under § 1361(e)(3). However, the
ineffectiveness of X’s S corporation election was inadvertent within the meaning of
§ 1362(f). Accordingly, X shall be treated as an S corporation from Date 2 and
thereafter, provided its S corporation election is not otherwise terminated under
§ 1362(d).

        This letter ruling is subject to the conditions that within 120 days from the date of
this letter (1) the trustees of Trust 1 and Trust 2 file ESBT elections with respect to Trust
1 and Trust 2, effective Date 2, with the appropriate service center and (2) X and its
shareholders file any necessary original or amended returns consistent with the relief
granted in this letter. A copy of this letter should be attached to the ESBT election and
any original or amended returns.

       If the above conditions are not met, then this ruling is null and void. Also, 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 as specifically ruled above, we express or imply no opinion concerning
the federal tax consequences of the facts described above under any other provision of
the Code and the regulations thereunder, including whether X was otherwise a valid S
corporation or whether Trust 1 and Trust 2 are valid ESBTs within the meaning of
§ 1361(e).

       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.

      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.
PLR-107710-24                                             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,




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




Enclosure
      Copy for § 6110 purposes



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