Inadvertent termination of an S election relieved after trusts failed to make ESBT elections

Plain-English summary

A corporation had elected to be an S corporation, which passes income
through to shareholders instead of paying corporate-level tax. S
corporations can only have certain kinds of shareholders. Here, company
stock was transferred to five trusts. Those trusts could have qualified
as electing small business trusts (ESBTs), which are permitted S
corporation shareholders, but the trustees never filed the required ESBT
elections. Because the trusts were therefore ineligible shareholders, the
company's S election automatically terminated, and later stock transfers
would have terminated it again. The company asked the IRS to treat the
termination as inadvertent under section 1362(f). The IRS agreed: it found
the lapse inadvertent and not tax-motivated, so the company will be
treated as continuing to be an S corporation without interruption. Relief
is conditioned on the trustees filing the ESBT elections (effective the
original transfer date) and the trusts filing returns, including amended
returns, within 120 days.

Ruling snapshot

• Question: Was the termination of the company's S election (caused by trusts failing to make ESBT elections) inadvertent under section 1362(f)?
• Outcome: Approved (treated as a continuing S corporation, conditioned on filing ESBT elections and returns within 120 days)
• Key authorities: IRC §§ 1362(f), 1362(d)(2), 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: 202601001
Release Date: 1/2/2026
Index Number: 1362.04-00

Third Party Communication: None
Date of Communication: Not Applicable

Person To Contact:
-------------------------, ID No. -----------------
Telephone Number:
Refer Reply To: CC:PSI:B03
PLR-107136-24
Date: September 29, 2025

Legend

X = ---
Trust 1 = ---
Trust 2 = ---
Trust 3 = ---
Trust 4 = ---
Trust 5 = ---
Date 1 = ---
Date 2 = ---
Date 3 = ---
Date 4 = ---
Date 5 = ---
Date 6 = ---
Date 7 = ---
State = ---
Years = ---

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

   This letter responds to a letter dated April 10, 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 under the laws of State on Date 1 and elected to be an S corporation effective Date 2. On Date 3, shares of X stock were transferred to each of Trust 1, Trust 2, Trust 3, Trust 4, and Trust 5 (collectively, the Trusts). X represents that on Date 3 each of the Trusts qualified as an electing small business trust (ESBT) within the meaning of § 1361(e). However, the trustees of the Trusts failed to make elections under § 1361(e)(3) treating the Trusts as ESBTs effective Date 3. Therefore, X had ineligible S corporation shareholders on Date 3, causing X's S corporation election to terminate on Date 3.

   On Date 4 and Date 7, additional shares of X stock were transferred to the Trusts. At the time of the transfers, the Trusts were ineligible S corporation shareholders. Consequently, X's S corporation election would have terminated on Date 4 and Date 7 had it not already terminated on Date 3.

   On Date 5 and Date 6, additional shares of X stock were transferred to each of Trust 4 and Trust 5. At the time of the transfers, Trust 4 and Trust 5 were ineligible S corporation shareholders. Consequently, X's S corporation election would have terminated on Date 5 and Date 6 had it not already terminated on Date 3.

    X 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. Also, X represents that X and its shareholders have filed all returns consistent with X's status as an S corporation. Finally, 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)(v) provides that, for purposes of § 1361(b)(l)(B), an ESBT may be an S corporation shareholder.

   Section 1361(e)(1)(A) provides that, 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 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 § 1.1361-2(m)(2)(ii).

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

   Section 1362(d)(2)(A) provides that an election under § 1362(a) 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(d)(2)(B) provides that any termination under § 1362(d)(2) shall be 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 terminated under § 1362(d)(2); (2) the Secretary determines that the circumstances resulting in such termination were inadvertent; (3) no later than a reasonable period of time after discovery of the circumstances resulting in such termination, steps were taken so that the corporation for which the termination occurred is a small business corporation; and (4) the corporation for which the termination occurred and each person who was a shareholder in the corporation at any time during the period specified pursuant to § 1362(f), agrees to make any adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to the period, then, notwithstanding the circumstances resulting in the termination, the 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 shares of X stock were transferred to ineligible S corporation shareholders. In addition, had X's S corporation election not terminated on Date 3, it would have terminated on Date 4, Date 5, Date 6, and Date 7 when additional shares of X stock were transferred to ineligible S corporation shareholders. 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) for reasons not addressed in this letter.

    This ruling is contingent on (1) the trustees of the Trusts filing ESBT elections effective Date 3 for each of the Trusts with the appropriate service center within one hundred-twenty (120) days from the date of this letter, and (2) the Trusts filing returns, including amended returns, for Years with the appropriate service center within 120 days from the date of this letter to properly reflect the treatment of the Trusts as ESBTs effective Date 3. A copy of this letter should be attached to each ESBT election and the returns.

  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 or the Trusts' eligibility to be ESBTs.

   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 requested ruling, it is subject to verification on examination.

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

                                           Sincerely,

                                           Mary Beth Carchia
                                           Senior Technician Reviewer, Branch 3
                                           Office of the Associate Chief Counsel
                                           (Passthroughs & Special Industries)

Enclosure:
Copy of this letter for § 6110 purposes

cc: ---