Corporation kept S status after a trust missed its ESBT election

Plain-English summary

An irrevocable trust acquired stock in an S corporation and qualified to elect treatment as an electing small business trust, but its trustee did not file the ESBT election on time. The trust therefore became an ineligible shareholder and technically terminated the corporation’s S election. The corporation, trust, and shareholders consistently filed returns as though S corporation and ESBT status had remained effective, and the trust later distributed all shares to individual beneficiaries. The IRS found that the termination was inadvertent and ruled that the corporation would be treated as continuously maintaining S status under IRC § 1362(f). It also treated the trust as an ESBT during the period it held the shares. Relief is conditioned on filing the ESBT election within 120 days and filing any required original or amended returns for open years consistently with the ruling.

Ruling snapshot

• Question: Was the corporation’s S election inadvertently terminated when its trust shareholder missed the ESBT election?
• Outcome: Approved
• Key authorities: IRC §§ 1361(a), 1361(b), 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: 202515006
Third Party Communication: None
Release Date: 4/11/2025
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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CC:PSI:01
PLR-113166-24
Date:
January 06, 2025

LEGEND

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

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

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

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

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

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

This letter responds to a letter dated June 6, 2024, and subsequent correspondence, submitted on behalf of X by its authorized representatives, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.
PLR-113166-24
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FACTS

The information submitted states that X was incorporated under the laws of State on Date 1 and elected to be taxed as an S corporation effective Date 2.

Trust, an irrevocable trust, acquired shares in X on Date 3. X represents that Trust qualified to elect to be treated as an Electing Small Business Trust (ESBT) as of Date 3. However, the trustee of Trust failed to make a timely ESBT election under § 1361(e)(3) effective Date 3. Consequently, Trust was an ineligible shareholder of X thereby causing X’s S corporation status to terminate on Date 3. Nevertheless, X represents that Trust has filed federal income tax returns consistent with having a valid ESBT election in place since Date 3. On Date 4, Trust distributed all of its shares of X stock to Trust’s individual beneficiaries.

X represents that X and its shareholders have filed tax returns consistent with being an S corporation for all relevant periods. X further represents that the circumstances resulting in the termination of its S corporation election were inadvertent and were not motivated by tax avoidance or retroactive tax planning. X and its shareholders have agreed to make adjustments consistent with the treatment of X as an S corporation, as may be required by the Secretary.

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 the 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 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.
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Section 1361(e)(1)(B) provides that an ESBT does not include (i) any qualified subchapter S trust (as defined in § 1361(d)(3)) if an election under § 1361(d)(2) applies to any corporation the stock of which is held by such trust, (ii) any trust exempt from tax under subtitle A, and (iii) any charitable remainder annuity trust or charitable remainder unitrust (as defined in § 664(d)).

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 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 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)(A) provides that 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. 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 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 paragraph (2) or (3) of § 1362(d); (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 (A) so that the corporation is a small business corporation, or (B) to acquire the required 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 such ineffectiveness or termination, the corporation shall be treated as an S corporation during the period specified by the Secretary.
PLR-113166-24
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CONCLUSION

Based solely on the information submitted and the representations made, we conclude that X's S corporation election terminated on Date 3 when Trust 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 beginning on and after Date 3, unless X's S corporation election is otherwise terminated under § 1362(d) for reasons not addressed in this letter.

We additionally conclude that Trust will be treated as an ESBT from Date 3 until Date 4. This ruling is contingent on the trustee of Trust filing within 120 days from the date of this letter (1) an election to treat Trust as an ESBT effective Date 3 with the appropriate service center and (2) to the extent that X and each of its shareholders have not already do so, filing all required returns (original or amended) 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 and any such returns.

If the conditions are not met, this ruling is null and void. In addition, 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 above, we express or imply no opinion concerning the federal tax consequences of the facts described above under any other provision of the Code. Specifically, we express or imply no opinion regarding whether X is otherwise eligible to be an S corporation or whether Trust is otherwise eligible to be an ESBT.

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 ruling request, it is subject to verification upon examination.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.
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In accordance with the power of attorney on file with this office, we are sending copies of this letter to X's authorized representatives.

Sincerely,

Jennifer N. Keeney
Senior Counsel, Branch 1
Office of Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosure
Copy of letter for § 6110 purposes

cc:
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