Missed ESBT and QSST elections do not end S corporation status

Plain-English summary

Six trusts eligible for electing small business trust treatment and two trusts eligible for qualified subchapter S trust treatment received shares of an S corporation, but the required elections were not filed on time. The corporation and its shareholders had consistently filed returns as if the S election remained effective, and they represented that the omissions were inadvertent rather than tax-motivated. The IRS ruled that the missed trust elections caused a technical termination but treated it as inadvertent under section 1362(f). The corporation could continue as an S corporation if the six ESBT elections and two QSST elections were filed with their original effective dates within 120 days and all parties maintained consistent treatment.

Ruling snapshot

• Question: Could the corporation retain S status after six missed ESBT elections and two missed QSST elections?
• Outcome: approved, conditioned on filing all eight trust elections within 120 days
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1361-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201707002 Third Party Communication: None
Release Date: 2/17/2017 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------------- --------------------, ID No. ------------------
--------------------------------- Telephone Number:
----------------------------- ----------------------
------------------------------------ Refer Reply To:
-------------------------------- CC:PSI:B03
PLR-114454-16
Date:
October 31, 2016

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

State = -----------------
D1 = ----------------------
D2 = ---------------------------
D3 = ---------------------------
D4 = -----------------------
D5 = ---------------------------
D6 = --------------------------
Trust 1 = ------------------------------------------------------------------------------------------
------------------------------------
Trust 2 = ------------------------------------------------------------------------------------------
------------------------------------
Trust 3 = ------------------------------------------------------------------------------------------
------------------------------------
Trust 4 = ------------------------------------------------------------------------------------------
------------------------------------
Trust 5 = ------------------------------------------------------------------------------------------
------------------------------------
Trust 6 = ------------------------------------------------------------------------------------------
------------------------------------
Trust 7 = ---------------------------------------
Trust 8 = ---------------------------------------
A = --------------------------------
B = ----------------------
C = ----------------------------
D = ----------------------

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

   This responds to a letter dated April 12, 2016, submitted on behalf of X by its

authorized representative, requesting rulings under § 1362(f) of the Internal Revenue
Code.
PLR-114454-16 2

   The information submitted states that X was incorporated under the laws of State

and elected to be an S corporation effective D1. On D2, each of Trust 1, Trust 2, Trust
3, Trust 4, Trust 5 and Trust 6 were created. Each of Trust 1, Trust 2, Trust 3, Trust 4,
Trust 5 and Trust 6 also received shares of X on D2. Trust 1, Trust 2 and Trust 3 have
been shareholders of X at all times since D2. On D3, the respective shares of X owned
by Trust 5 and Trust 6 were cancelled and new shares were issued to A and B,
respectively. On D4, the shares of X owned by Trust 4 were distributed to C, as
custodian of D. The information submitted further states that Trust 7 was established
on D5 and that Trust 7 received shares of X beginning on D5. Finally, Trust 8 was
established on D6 and received shares of X on or after D6.

    X represents that each of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5 and Trust 6

has met the electing small business trust (ESBT) requirements under § 1361(e)(1) at all
relevant times since and including D2. However, the respective trustees of the six trusts
failed to file an ESBT election with respect to each of the six trusts. X further represents
that Trust 7 and Trust 8 have been eligible to elect qualified subchapter S trust (QSST)
treatment under § 1361(d). However, the respective beneficiaries of Trust 7 and Trust 8
inadvertently failed to timely make a QSST election with respect to these trusts.

   X represents that the respective failures to file ESBT or QSST elections were

inadvertent and not motivated by tax avoidance or retroactive tax planning. X further
represents that from D2, X and its shareholders have filed all returns consistent with X’s
status as an S corporation. X and its shareholders have agreed to make such
adjustments (consistent with the treatment of X as an S corporation) as may be required
by the Secretary.

   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.

   Section 1361(d)(1) provides that in the case of a QSST for which a beneficiary

makes an election under § 1361(d)(2), the trust is treated as a trust described in
§ 1361(c)(2)(A)(i), and for purposes of § 678(a), the beneficiary of the trust shall be
treated as the owner of that portion of the trust that consists of stock in an S corporation
with respect to which the election under § 1361(d)(2) is made.

  Section 1361(d)(2)(A) provides that a beneficiary of a QSST may elect to have

§ 1361(d) apply. Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary
of a QSST must make the election under § 1361(d)(2) by signing and filing with the
PLR-114454-16 3

service center with which the corporation files its income tax returns the applicable form
or a statement including the information listed in § 1.1361-1(j)(6)(ii).

   Section 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as

provided in § 1361(e)(2)(B), an ESBT means any trust if (1) 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.

   Section 1.1361-1(m)(2)(i) of the Income Tax Regulations provides 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(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)
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.

   Based solely on the facts submitted and the representations made, we conclude

that X's S corporation election terminated on D2, because of the failure of the trustees
of Trust 1, Trust 2, Trust 3, Trust 4, Trust 5 and Trust 6 to make the required ESBT
elections. We further conclude that if the trustees of Trust 1, Trust 2, Trust 3, Trust 4,
Trust 5 and Trust 6 did make the required ESBT elections, then X’s S corporation
election would have terminated on D5, due to the failure of the beneficiary of Trust 7 to
PLR-114454-16 4

file a QSST election with respect to Trust 7, or on D6, due to the failure of the
beneficiary of Trust 8 to file a QSST election with respect to Trust 8. Finally, we
conclude that this termination of X's S corporation election was an inadvertent
termination 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 D2 and thereafter,
provided X's S corporation election was valid and not otherwise terminated under
§ 1362(d).

    This ruling is contingent upon the respective trustees of Trust 1, Trust 2, Trust 3,

Trust 4, Trust 5 and Trust 6 filing ESBT elections for Trust 1, Trust 2, Trust 3, Trust 4,
Trust 5 and Trust 6, with an effective date of D2 with the appropriate service center
within 120 days of the date of this ruling. A copy of this letter should be attached to each
of the ESBT elections. This ruling is further contingent on the respective beneficiaries of
Trust 7 and Trust 8 filing QSST elections for Trust 7 and Trust 8 with effective dates of
D5 and D6, respectively, with the appropriate service center within 120 days of the date
of this ruling. A copy of this letter should be attached to the QSST elections. If X or its
shareholders fail to treat X as described above, this letter ruling will be null and void.

   Except as specifically set forth above, no opinion is expressed concerning the

federal tax consequences of the facts described above under any other provision of the
Code, including whether X is a small business corporation under § 1361(b), or whether
Trust 1, Trust 2, Trust 3, Trust 4, Trust 5 or Trust 6 is an ESBT within the meaning of §
1361(e), or whether Trust 7 and Trust 8 is a QSST within the meaning of § 1361(d)(3).

    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,



                                  Bradford R. Poston
                                  Senior Counsel, Branch 3
                                  Office of the Associate Chief Counsel
                                  (Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes

cc: