Corporation receives relief for an inadvertent S election termination

Plain-English summary

A grantor trust held shares in an S corporation, but its owner died and the trust did not timely elect treatment as an electing small business trust. Because the trust then became an ineligible shareholder, the corporation's S election terminated. The IRS found that the termination was inadvertent under section 1362(f) and agreed to treat the corporation as continuously maintaining S status. The relief is conditioned on the trust filing an ESBT election effective on the termination date within 120 days.

Ruling snapshot

• Question: Could the corporation preserve its S status after a trust shareholder failed to make an ESBT election?
• Outcome: approved, if the trust files the required ESBT election within 120 days
• Key authorities: IRC §§ 1361(b), 1361(c), 1361(e), 1362(d), 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: 201717016                                            Third Party Communication: None
Release Date: 4/28/2017                                      Date of Communication: Not Applicable
Index Numbers: 1362.04-00
                                                             Person To Contact:
-------------------------------------------                  --------------------------, ID No. ----------------
---------------------------------------                      -----------------
------------------------------------------                   Telephone Number:
------------------------------                               ----------------------
                                                             Refer Reply To:
                                                             CC:PSI:B03
                                                             PLR-127283-16
                                                             Date:
                                                             January 12, 2017

Legend

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

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

D1                = ----------------------

D2                = -----------------

D3                = ----------------------------

D4                = ----------------------------

Trust             = ----------------------------------------------------------------------------------------------
                    -------------------------------


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

       This letter responds to a letter dated August 31, 2016, and subsequent
correspondence submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code (Code).

                                                    FACTS

      The information submitted states that X was organized under the laws of State
on D1 and elected to be an S corporation effective D2. Trust, a shareholder in X, was a
grantor trust until D3, when Trust’s owner died. Trust was eligible on D3 and thereafter
to make an election to be treated as an electing small business trust (ESBT). However,
PLR-127283-16                                 2

Trust failed to file an ESBT election. Therefore, on D4, X’s S corporation election
terminated.

       X represents that the termination was not motivated by tax avoidance or
retroactive tax planning. X further represents that it has filed consistently as an S
corporation since D2. X and its shareholder have agreed to make any adjustments that
the Commissioner may require, consistent with the treatment of X as an S corporation.

                                  LAW AND ANALYSIS

      Section 1362(a) provides that, except as provided in § 1362(g), a small business
corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

        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 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 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 1 of subchapter J of Chapter 1) as owned by
an individual who is a citizen or resident of the United States may be a shareholder.

        Section 1361(e) defines an ESBT. Section 1361(e)(1)(A) provides that, except as
provided in § 1362(e)(2)(B), 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 PCB, (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) 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)(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
PLR-127283-16                                 3

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 terminated under § 1362(d)(2) or (3), (2) the Secretary
determines that the circumstances resulting in the termination were inadvertent, (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
the termination, steps were taken (A) so that the corporation is a small business
corporation, 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 termination, the corporation will be
treated as an S corporation during the period specified by the Secretary.

                                      CONCLUSION

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on D4 when X had an ineligible shareholder.
We also conclude that the circumstances resulting in the termination were inadvertent
within the meaning of § 1362(f). Accordingly, under § 1362(f), X will be treated as an S
corporation from D4 and thereafter, provided X’s S corporation election was otherwise
valid and has not otherwise terminated under § 1362(d) for reasons not addressed in
this letter.

        This ruling is conditioned on the Trust filing an ESBT election, effective D4, with
the appropriate service center within 120 days of the date of this letter. A copy of this
letter should be attached to the ESBT election.

       Except as specifically ruled above, we express or imply no opinion concerning
the federal tax consequences of the facts described above under any other provisions
of the Code. Specifically, we express or imply no opinion regarding X’s eligibility to be
an S corporation under § 1361, or to the continued validity of any rulings issued in PLR-
100826-08 with respect to the transactions proposed, but not yet consummated, by X.
PLR-127283-16                                4


       This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
of the Code provides that it may not be used or cited as precedent.

      In accordance with a power of attorney on file with this office, we are sending a
copy of this letter to X’s authorized representative.

                                          Sincerely,


                                          Richard T. Probst
                                          Senior Technician Reviewer, Branch 3
                                          Office of the Associate Chief Counsel
                                          (Passthroughs and Special Industries)
Enclosures (2):

       Copy of this letter
       Copy for § 6110 purposes


cc: