Missed ESBT election caused an inadvertent S corporation termination

Plain-English summary

After a shareholder died, the shareholder's estate transferred S corporation stock to a trust intended to qualify as an electing small business trust. The trustee failed to make the required ESBT election, which terminated the corporation's S election. The corporation represented that the failure was inadvertent, did not involve tax avoidance or retroactive 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 a timely ESBT election, amended trust returns and adjustments, and a specified payment to the IRS.

Ruling snapshot

• Question: Was the S corporation termination inadvertent when a trustee failed to make an ESBT election?
• Outcome: approved, subject to corrective filings, adjustments, and payment
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 1362(d), 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                    Department of the Treasury
                                                            Washington, DC 20224

Number: 201748003                                           Third Party Communication: None
Release Date: 12/1/2017                                     Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                            Person To Contact:
-----------------------------                               --------------------, ID No. ------------------
---------------------------------                           Telephone Number:
--------------                                              ----------------------
---------------------                                       Refer Reply To:
-------------------------------------                       CC:PSI:BR03
                                                            PLR-108802-17
                                                            Date:
                                                            August 31, 2017




                                                  LEGEND

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

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

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

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

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

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

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

$n             = ------------------

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

Years          = -----------------

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

        This letter responds to a letter dated March 7, 2017, submitted on behalf
of X, requesting a ruling under § 1362(f) of the Internal Revenue Code (the Code).
PLR-108802-17                                2

                                          FACTS

      The information submitted states that X was incorporated under the laws of State
on Date 1 and elected to be treated as an S corporation effective Date 1.

       A, a shareholder of X, died on Date 2. On Date 3, A’s estate transferred shares
of X stock to Trust. X represents that Trust qualifies as an electing small business trust
(ESBT) within the meaning of § 1361(e). However, the trustee of Trust failed to make
an election under § 1361(e)(3) to treat Trust as an ESBT. As a result, X’s S corporation
election terminated on Date 3.

       X represents that the failure to file an ESBT election and resulting termination of
its S corporation election were inadvertent and were not motivated by tax avoidance or
retroactive tax planning. Further, X and its shareholders agree to make any
adjustments consistent with the treatment of X as an S corporation as may be required
by the Secretary.

                                           LAW

        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
one class of stock.

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

         Section 1361(e)(1)(A) provides that 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-108802-17                                 3


        Section 1.1361-1(m)(2)(i) of the Income Tax Regulations provides, in relevant
part, 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) 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, in relevant part, that if (1) an election under § 1362(a)
by any corporation was terminated under § 1362(d)(2); (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 in such corporation at any time
during the period specified pursuant to § 1362(f), agrees to make the adjustments
(consistent with the 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 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 corporation election terminated on Date 3 when the trustee of Trust failed to
file an ESBT election under § 1361(e)(3). We further conclude that the termination of
X's S corporation election was inadvertent within the meaning of § 1362(f). Therefore,
under § 1362(f) X will be treated as continuing to be an S corporation on and after Date
3, provided X's S corporation election was otherwise valid and not otherwise terminated
under § 1362(d).

       This ruling is contingent on the following: (1) the trustee of Trust filing within 120
days of the date of this letter an ESBT election effective Date 3 with the appropriate
service center; and (2) Trust filing within 120 days of the date of this letter any amended
returns and making adjustments to properly reflect the treatment of Trust as an ESBT
for Years taxable years.

        Furthermore, as an adjustment under § 1362(f)(4), a payment of $n 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
PLR-108802-17                                  4

-----------------, Manual Deposit. This payment and a copy of this letter must be sent no
later than Date 4.

       If the above conditions are not met, then this ruling is null and void. In addition, if
these conditions are not met, X must send notification that its S corporation election has
terminated to the service center with which X’s S corporation 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 who requested it. According to
§ 6110(k)(3) of the Code, this ruling may not be used or cited as precedent.

       The ruling contained in this letter is 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 ruling request, it is subject to verification on examination.

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


                                       Sincerely,



                                       Mary Beth Carchia
                                       Senior Technician Reviewer, Branch 3
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

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