Missed ESBT election caused an inadvertent S corporation termination

Plain-English summary

Two shareholders transferred S corporation stock to a trust intended to qualify as an electing small business trust. The trustee did not make the required ESBT election, leaving the trust ineligible to hold the stock and terminating the corporation's S election. The corporation represented that the failure was inadvertent, did not involve tax avoidance or retroactive tax planning, and would be corrected with any required adjustments. The IRS ruled that the corporation would be treated as continuously maintaining S status. Relief was conditioned on the trustee filing the ESBT election and all required original or amended returns before the earlier of 120 days or the closing of any affected year under section 6501(a).

Ruling snapshot

• Question: Was the S corporation termination inadvertent when a trust received stock but its trustee failed to make an ESBT election?
• Outcome: approved, subject to corrective election and return filings
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 1362(d), 1362(f), 6501(a)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201747004                                             Third Party Communication: None
Release Date: 11/24/2017                                      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-118874-17
                                                              Date:
                                                              August 29, 2017


                                                       LEGEND

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

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

B           =     --------------------------------------------------------------------------------------------------
                  -------------------------

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

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

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

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

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

n           =     ---------------------------------------------


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

       This letter responds to a letter dated June 13, 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-118874-17                                 2



                                          FACTS

        X was incorporated under the laws of State on Date 1. X made an S corporation
election effective Date 2. On Date 3, A and B transferred shares of X stock to Trust. X
represents that Trust was qualified to be an Electing Small Business Trust (ESBT)
within the meaning of § 1361(e), however, no election was made under § 1361(e)(3) to
treat Trust as an ESBT. Consequently, Trust was an ineligible shareholder and, as a
result, X’s S corporation election was terminated.

       X represents that the circumstances resulting in the termination of X’s S
corporation election were inadvertent and not motivated by tax avoidance or retroactive
tax planning. X and X’s shareholders agree to make any adjustments consistent with
the treatment of X as an S corporation as may be required by the Secretary with respect
to the period specified by § 1362(f).

                                  LAW AND ANALYSIS

        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) 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 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 § 1361(b)(1)(B), an ESBT
is a permissible shareholder.

         Section 1361(e)(1)(A) provides that, except as provided in § 1361(e)(1)(B), the
term “electing small business trust” 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) through (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
PLR-118874-17                                 3

and all subsequent taxable years of such trust unless revoked with the consent of the
Secretary.

       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 pertinent 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 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 the adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to this 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.

                                      CONCLUSION

        Based solely on the information submitted and the representations made, we
conclude that X’s S corporation election terminated on Date 3 because X had an
ineligible shareholder. We further conclude that the termination was inadvertent within
the meaning of § 1362(f). Pursuant to the provisions of § 1362(f), X will be treated as
continuing to be an S corporation from Date 3, and thereafter, provided that X’s S
corporation election was otherwise valid and has not otherwise terminated under
§ 1362(d).

        This ruling is contingent on the trustee of Trust filing, within the sooner of 120
days following the date of this letter or the date any year will close under § 6501(a):
(1) an ESBT election effective Date 3, and (2) all required returns, including amended
returns, for n consistent with the requested relief during the period at issue. A copy of
this letter should be attached to the ESBT election and any income tax return to which it
is relevant.

      The rulings contained in this letter are based upon information and
representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.
PLR-118874-17                                   4

       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, including X’s eligibility to be a valid 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.

         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/

                                         Holly Porter
                                         Chief, Branch 3
                                         Office of the Associate Chief Counsel
                                         (Passthroughs and Special Industries)

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



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