Corporation retained S status after trust missed ESBT election

Plain-English summary

A trust that owned stock in an S corporation ceased qualifying under its prior shareholder status and became eligible to be an electing small business trust, but its trustee failed to make the ESBT election. That made the trust an ineligible shareholder and technically terminated the corporation's S election. The corporation and shareholders nevertheless filed consistently with S corporation and ESBT treatment, represented that the mistake was inadvertent and not tax-motivated, and agreed to any required adjustments. The IRS treated the corporation as continuously maintaining S status, conditioned on the trustee filing an ESBT election effective on the original date within 120 days.

Ruling snapshot

• Question: Was the S corporation's termination inadvertent when a shareholder trust failed to make a timely ESBT election?
• Outcome: Approved
• Key authorities: IRC §§ 1361(c)(2), 1361(e), and 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: 202527005
Third Party Communication: None
Release Date: 7/3/2025
Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PT&E:B03
PLR-116852-24
Date:
March 21, 2025

LEGEND

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

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

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

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

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

This letter responds to a letter dated September 9, 2024, 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 on Date 1 under the laws of State and elected to be an S corporation effective Date 2. X represents that prior to Date 3, Trust, an owner of X stock, was an eligible S corporation shareholder under § 1361(c)(2)(A)(i).

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X represents that on Date 3, Trust qualified as an electing small business trust (ESBT) within the meaning of § 1361(e)(1)(A). However, the trustee of Trust failed to make an election under § 1361(e)(3) to treat Trust as an ESBT effective Date 3. Thus, Trust was an ineligible shareholder of X on Date 3, causing X's S corporation election to terminate on Date 3.

X represents that 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 represents that it and its shareholders have filed all returns consistent with X’s status as an S corporation, and that Trust has filed all returns consistent with its status as an ESBT effective Date 3. X and its shareholders agree to make any adjustments required by the Secretary 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.

Section 1361(b)(1) provides that the term “small business corporation” means a domestic corporation that is not an ineligible corporation and that 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)(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 of the Code) 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

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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 1362(a) provides that a small business corporation may elect to be an S corporation.

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, 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), (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 in such corporation at any time during the period specified pursuant to § 1362(f), agree 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.

CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X's S corporation election terminated on Date 3 when it had an ineligible S corporation shareholder 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, X will be treated as continuing to be 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 contingent upon the trustee of Trust filing an ESBT election for Trust effective Date 3 with the appropriate service center within one hundred-twenty

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(120) days from the date of this letter. A copy of this letter should be attached to the 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, Trust’s eligibility to be an S corporation shareholder, or Trust's eligibility to be an ESBT.

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3) of the Code, this ruling may not be used or cited as precedent.

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

Sincerely,

/s/

Mary Beth Carchia
Senior Technician Reviewer, Branch
3
Office of the Associate Chief
Counsel (Passthroughs, Trusts, and
Estates)

Enclosure:
Copy of this letter for § 6110 purposes

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