Missed ESBT election caused an inadvertent S corporation termination

Plain-English summary

After an S corporation shareholder died, the shareholder's stock passed to a testamentary trust that could hold S corporation stock for two years. The trustee failed to elect electing small business trust status when that two-year period ended, which made the trust an ineligible shareholder and terminated the corporation's S election. The corporation and its shareholders continued reporting as though S status remained in effect and represented that the failure was not tax-motivated. The IRS treated the termination as inadvertent and allowed the corporation to remain an S corporation. Relief required the trustee to file an effective ESBT election and all required consistent returns by the earlier of 120 days or the closing of any affected year under the assessment limitation period.

Ruling snapshot

• Question: Could the corporation retain S status after a trust missed the deadline for an ESBT election?
• Outcome: Approved as an inadvertent termination, subject to timely ESBT and return filings.
• Key authorities: IRC §§ 1361(c), (e), 1362(d), (f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201743015                                             Third Party Communication: None
Release Date: 10/27/2017                                      Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
                                                              Person To Contact:
-----------------------------------                           ----------------------, ID No. ------------------
--------------------------------------------                  Telephone Number:
-----------------------------                                 ----------------------
 ----------------------------------------                     Refer Reply To:
                                                              CC:PSI:B03
                                                              PLR-116698-17
                                                              Date:
                                                              July 27, 2017


                                                    LEGEND

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

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

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

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

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

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

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

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

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


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

       This letter responds to a letter dated May 9, 2017, and subsequent
correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling under § 1362(f) of the Internal Revenue Code.
PLR-116698-17                                 2

       The information submitted states that X was incorporated in State on Date 1. X
elected to be an S corporation effective Date 2. On Date 3, A, a shareholder of X, died
and A’s shares of X stock were transferred to Trust. Trust qualified as an eligible
shareholder for the next two years until Date 4 pursuant to § 1361(c)(2)(A)(iii).
However, the trustee of Trust failed to timely file the election under § 1361(c) to treat
Trust as an electing small business trust (ESBT) effective Date 4. Trust continued to
hold X stock until Date 5.

       X represents that the termination was not motivated by tax avoidance or
retroactive tax planning. X further represents that X and its shareholders continued to
treat X as an S corporation. X and its shareholders agree to make such adjustments
consistent with the treatment of X as an S corporation as required by the Commissioner.

      Section 1362(a) provides that a small business corporation may elect 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 a tax year.

       Section 1361(b)(1)(B) provides that for purposes of subchapter S, a “small
business corporation” cannot 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(c)(2)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust to
which stock is transferred pursuant to the terms of a will may be a shareholder, but only
for the two year period beginning on the day on which such stock is transferred to it.

     Section 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an ESBT
may be a shareholder.

       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 (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)(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.
PLR-116698-17                                  3


       Section 1.1361-1(m)(2)(i) of the Income Tax Regulations provides, in part, that
the trustee of the trust 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 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(f) provides 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 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 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 such termination, the corporation shall be treated as an S corporation during the
period specified by the Secretary.

        Based solely upon the facts submitted and the representations made, we
conclude that the termination of X’s S corporation election on Date 4 was inadvertent
within the meaning of § 1362(f). We further hold that, pursuant to the provisions of
§ 1362(f), X will be treated as continuing to be an S corporation from Date 4 provided
X's S corporation election was valid and was not otherwise terminated under § 1362(d).

       This ruling is contingent on the following: (1) the trustee of Trust must file, within
the sooner of 120 days following the date of this letter or the date any year will close
under § 6501(a), an ESBT election effective Date 4; and (2) Trust must file within that
same period all required returns, including amended returns, for all open years
consistent with the requested relief. If X or its shareholders fail to treat themselves as
described above, this ruling is 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. Specifically, no opinion is expressed regarding X’s eligibility to be an S
corporation or the validity of its S corporation election. Further, no opinion is expressed
as to whether Trust qualifies as an ESBT.
PLR-116698-17                                  4

      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.

         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,

                                       /s/

                                       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: