Corporation kept S status after a trust missed its ESBT election

Plain-English summary

After a shareholder died, the shareholder's estate transferred S corporation stock to a trust under the will. The trust could hold the shares temporarily but failed to make a timely electing small business trust election, causing the corporation's S election to terminate. The trust otherwise met the ESBT requirements, later distributed the shares, and the corporation continued filing as an S corporation. The IRS found the termination inadvertent and treated the corporation as an S corporation throughout the affected period. Relief required, within 120 days, a specified adjustment payment, consistent original or amended returns by the corporation and affected parties, and a retroactive ESBT election. The ruling would be null and void if those conditions were not met.

Ruling snapshot

• Question: Could the corporation obtain inadvertent-termination relief after the shareholder trust missed its ESBT election?
• Outcome: approved
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201737005                                              Third Party Communication: None
Release Date: 9/15/2017                                        Date of Communication: Not Applicable
Index Number: 1361.03-03, 1362.02-02,
              1362.04-00                                       Person To Contact:
                                                               ----------------, ID No. ------------------
                                                               Telephone Number:
------------------------------------------------               --------------------
------------------------------                                 Refer Reply To:
------------------------                                       CC:PSI:B01
----------------------------------------------                 PLR-138489-16
                                                               Date:
                                                               June 12, 2017




LEGEND

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

A        =        ----------------------------

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

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

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

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

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

Date 5=           ----------------------

Date 6=           ---------------------------

Years1=           ------------------------------

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

$a       =        -------------------------------------------------------------------------

PLR-138489-16                                 2



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

This responds to a letter dated December 7, 2016, and supplemental correspondence,
submitted on behalf of X, by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations within, X was incorporated
on Date 1, under the laws of State. On Date 1, A was a shareholder of X. A died on
Date 2 at which time A’s estate became a shareholder of X. Effective Date 3, X elected
to be taxed as an S corporation. On Date 4, A’s shares of X stock were transferred to
Trust, pursuant to the terms of A’s will. Trust qualified under § 1361(c)(2)(A)(iii) as an
eligible shareholder for a two-year period beginning on the day the shares of X were
transferred to it. A timely election to treat Trust as an Electing Small Business Trust
(ESBT) was not made, thus causing X’s S election to terminate on Date 5.

X represents that Trust has at all times met the requirements of an ESBT within the
meaning of § 1361(e), except that the trustee of Trust did not file a timely ESBT election
under § 1361(e)(3). X represents that Trust made a distribution of the X stock on Date

6. X also represents that the failure to file an ESBT election for Trust was inadvertent
and was not motivated by tax avoidance or retroactive tax planning.

X represents that, other than the failure of the trustee of Trust to file a timely ESBT
election on Date 4, X has qualified as a small business corporation at all times since its
election on Date 3. In addition, X represents that it has filed its returns consistent with
being an S corporation. X represents that its S corporation election termination was
inadvertent and was not motivated by tax avoidance or retroactive tax planning.
Further, X represents that X and its shareholders agree to make any adjustments
required as a condition of obtaining relief under the inadvertent termination rule as
provided under § 1362(f) of the Code that may be required by the Secretary.

LAW AND ANALYSIS

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) 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

PLR-138489-16                                 3

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 § 1362(b)(1)(B), an electing
small business trust (ESBT) may be an S corporation shareholder.

Section 1361(e) 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.

Section 1361(e)(1)(B) provides that the term “electing small business trust” shall 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) 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 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(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) or (3); (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 termination occurred is a small business corporation; and (4)
the corporation for which the election was made or termination occurred, and each
person who was a shareholder in such corporation at any time during the period
specified pursuant to § 1362(f), agrees to make the adjustments (consistent with the

PLR-138489-16                                4

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 the representations made, we conclude that
X’s S election terminated on Date 5 because of the failure of the trustee to timely file an
ESBT election for Trust. We further conclude that the termination of X’s S election was
inadvertent within the meaning of § 1362(f). Therefore, X will be treated as an S
corporation effective Date 5 and thereafter, provided X’s S corporation election is
otherwise valid and not otherwise terminated under § 1362(d).

This letter ruling is subject to the following conditions being met within 120 days from
the date of this letter: (1) an adjustment payment in the amount of $a and a copy of this
letter must be sent to the following address: Internal Revenue Service, Cincinnati
Service Center, 201 West Rivercenter Blvd., Covington, KY 41011, Stop 31, Terri
Lackey, Manual Deposit; (2) X, X’s shareholders, Trust and Trust’s beneficiary must file
any original and amended returns for Years1 and make such adjustments that are both
consistent with treating Trust as an ESBT and that are necessary to properly reflect the
reporting of X’s items of S corporation income; and (3) the trustee of Trust filing an
ESBT election under § 1361(e)(3), with the appropriate service center, to treat Trust as
an ESBT effective Date 4. A copy of this letter should be attached to the ESBT election.
If these conditions are not met, then this ruling is null and void. Furthermore, if these
conditions are not met, X must send notification that its S election has terminated to the
service center with which X’s S election was filed.

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 Trust’s eligibility to be an ESBT.

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

PLR-138489-16                                  5


In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                       Sincerely,

                                       Laura C. Fields


                                       Laura C. Fields
                                       Senior Technician Reviewer, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)



Enclosures (2)
 Copy of this letter
 Copy of this letter for section 6110 purposes




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