A missed ESBT election did not invalidate S corporation status permanently

Plain-English summary

A trust held stock when a corporation elected S status but did not timely elect treatment as an electing small business trust. Because the trust was then an ineligible shareholder, the corporation's S election was invalid from the outset. The corporation represented that the failure was inadvertent, not tax-motivated, and that the corporation and shareholders had consistently treated it as an S corporation. The IRS allowed S status to continue from the original effective date, conditioned on an adjustment payment and a corrective ESBT election within 120 days. The trust, corporation, shareholders, and beneficiaries also agreed to amend affected returns consistently with ESBT treatment.

Ruling snapshot

• Question: Could the corporation obtain relief from an invalid S election caused by a missed ESBT election?
• Outcome: Approved, conditioned on a specified adjustment payment and corrective ESBT election within 120 days.
• Key authorities: IRC §§ 1361, 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201744013                                              Third Party Communication: None
Release Date: 11/3/2017                                        Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.03-03
                                                               Person To Contact:
------------------------------------------------------------   -------------------, ID No. ------------------
-----------------------                                        Telephone Number:
--------------------------                                     --------------------
------------------------------                                 Refer Reply To:
---------------------------------------                        CC:PSI:B01
                                                               PLR-112454-17
                                                               Date:
                                                               July 19, 2017




LEGEND

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

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

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

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

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

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

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

Years 1=          ---------------

Years 2=          ---------------

State =           -------

$a       =        ------------------------------------------------------------------------------
PLR-112454-17                                 2



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

This responds to a letter dated April 10, 2017, submitted on behalf of X, requesting relief
under section 1362(f) of the Internal Revenue Code (the Code) for an inadvertent invalid
S corporation election.

FACTS

According to the information submitted and representations within, X was incorporated
under the laws of State on Date 1. On Date 2, A transferred his X shares to Trust. A
died on Date 3. S elected to be treated as an S corporation effective Date 4. At the
time of the election, Trust, a shareholder of X, was an ineligible shareholder. X’s S
corporation election was invalid due to the failure of Trust to file an ESBT election.

X represents that Trust has at all times met the requirements of an ESBT, within the
meaning of § 1361(d)(3), except that the trustee of Trust did not make a timely ESBT
election under §1361(e)(3). X further represents that Trust has not filed its income tax
returns consistent with being an ESBT for Years 1.

X represents that, other than the failure to make a valid ESBT election on Date 4, X has
qualified as a small business corporation at all times since its election on Date 4 and X
represents that X and its shareholders have treated X as an S corporation at all relevant
times. X further represents that X has filed its income tax returns consistent with having
a valid S election in effect for all taxable years since X elected to be an S corporation.

X further represents that X, its shareholders, and Trust’s beneficiaries, will amend their
income tax returns for Years 2 within 120 days of the date of this ruling letter to reflect
treatment of Trust as an ESBT.

X represents that the invalidity of its S corporation election 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) provides that an S corporation is a small business corporation for which
an election under § 1362(a) is in effect.

Section 1361(b)(1) provides that the terms “small business corporation” means a
domestic corporation which is not an ineligible corporation and which does not (A) have
PLR-112454-17                                 3

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 1 class of stock.

Section 1361(c)(2)(A)(i) provides that, for purposes of section 1361(b)(1), a trust all of
which is treated (under subpart E of part I of subchapter J of this chapter) as owned by
an individual who is a citizen or resident of the United States may be an S corporation
shareholder.

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

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 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(a)(1) provides that except as provided in subsection (g), a small business
corporation may elect to be an S corporation. Section 1362(a)(2) provides that an
election under § 1362(a) shall be valid only if all persons who are shareholders in such
corporation on the day on which such election is made consent to such election.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 1st taxable year for which the
corporation is an S corporation) such corporation ceases to be a small business
corporation.

Section 1362(f) provides, in relevant part, that if (1) an election under subsection (a) or
section 1361(b)(3)(B)(ii) by any corporation (A) was not effective for the taxable year for
which made (determined without regard to subsection (b)(2)) by reason of a failure to
meet the requirements of section 1361(b) or to obtain shareholder consents, or (B) was
terminated under paragraph (2) or (3) of subsection (d) or section 1361(b)(3)(C); (2) the
Secretary determines that the circumstances resulting in such ineffectiveness or
PLR-112454-17                                 4

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 (A) so that the corporation for which the election was made or the
termination occurred is a small business corporation or a qualified subchapter S
subsidiary, as the case may be, or (B) to acquire the required shareholder consents;
and (4) the corporation for which the election was made or the termination occurred,
and each person who was a shareholder in such corporation at any time during the
period specified pursuant to this subsection, agrees to make such adjustments
(consistent with the treatment of such corporation as an S corporation or a qualified
subchapter S subsidiary, as the case may be) 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 or
a qualified subchapter S subsidiary, as the case may be during the period specified by
the Secretary.

CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
the failure of Trust to make an ESBT election effective Date 4 caused X’s S corporation
election to be inadvertently invalid within the meaning of § 1362(f). Pursuant to the
provisions of § 1362(f), X will be treated as continuing to be an S corporation beginning
on and after Date 4, unless X's S corporation election is otherwise terminated under §
1362(d).

This letter ruling is subject to the following conditions: (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. This payment must be sent no later
than 120 days from the date of this letter; (2) within 120 days from the date of this letter,
an election to treat the Trust as an ESBT effective Date 4, must be made with the
appropriate service center. 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.

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.
PLR-112454-17                                5

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


                                      Sincerely,


                                      David R. Haglund

                                      David R. Haglund
                                      Branch Chief, 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