Corporation receives relief for a missed ESBT election

Plain-English summary

An S corporation had stock held by a grantor trust. After the grantor died, that trust became irrevocable and later transferred the shares to a second trust, but the second trust did not timely elect to be an electing small business trust. The missed ESBT election caused the corporation's S election to terminate, and the second trust also failed to file its returns consistently with ESBT treatment. The IRS accepted the corporation's representation that the termination was inadvertent and not motivated by tax avoidance or retroactive planning. It ruled that the corporation would continue to be treated as an S corporation, provided it remained otherwise eligible. Relief required an adjustment payment and a retroactive ESBT election within 120 days.

Ruling snapshot

• Question: May the corporation retain S status after a shareholder trust failed to make a timely ESBT election?
• Outcome: approved
• Key authorities: IRC §§ 1361 and 1362(d) and (f); Treas. Reg. §§ 1.1361-1(m) and 1.1362-4

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201801008                                             Third Party Communication: None
Release Date: 1/5/2018                                        Date of Communication: Not Applicable
Index Number: 1362.01-00, 1362.01-02,
              1362.02-00, 1362.02-02,                         Person To Contact:
              1362.04-00, 1362.00-00                          ----------------------------,
                                                              ID No. ------------------
------------------------------                                Telephone Number:
---------------------------------------                       ----------------------
---------------------------------                             Refer Reply To:
----------------------------------                            CC:PSI:B01
                                                              PLR-115705-17
                                                              Date:
                                                              September 28, 2017

LEGEND

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

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

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

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

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

Trust 1           = -----------------------------------------------------------------------------------------------
---------------------------------------------

Grantor           = ---------------------
-----------------------------------------------

Trust 2           = -----------------------------------------------------------------------------------------------
---------------------------------------------

PLR-115705-17                                2

a              = ------------

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

      This responds to a letter dated April 7, 2017, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting relief under
§ 1362(f) of the Internal Revenue Code (the Code).

FACTS

       According to the information submitted, X was incorporated under the laws of
State on Date 1. X elected to be treated as an S corporation effective Date 1.

        Trust 1 was a shareholder of X. Trust 1 was a trust all of which was treated
(under subpart E of part I of subchapter J) as owned by Grantor. Grantor was a U.S.
citizen. On Date 2, Grantor died and Trust 1 became irrevocable. On Date 3, Trust 1
transferred its X shares to Trust 2. A timely election to treat Trust 2 as an ESBT was
not made. As a result, X’s S election terminated on Date 3.

       X represents that Trust 2 has at all times met the requirements of an ESBT within
the meaning of § 1361(e). X further represents that it has filed its returns consistent
with being an S corporation. Throughout the period that Trust 2 has been a shareholder
of X, however, Trust 2 has not filed its federal income tax returns consistent with being
an ESBT. 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) 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 that is not an ineligible corporation and that 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.

PLR-115705-17                                 3

        Section 1361(c)(2)(A)(i) provides that a trust, all of which is treated (under
subpart E of part I of subchapter J of chapter 1) 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)(ii) provides that, for purposes of § 1361(b)(1)(B), a trust all
of which was treated (under subpart E of part I of subchapter J) as owned by an
individual who was a citizen or resident of the United States immediately before the
death of the individual may continue to be an S corporation shareholder for the 2-year
period beginning on the date of death.

       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(d)(2)(A) provides that an election under § 1362(a) shall be
terminated whenever the corporation ceases to be a small business corporation.

PLR-115705-17                                 4

       Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a)
by any corporation was terminated under paragraph (2) or (3) of § 1362(d), (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 termination, steps were taken so that the corporation is once
more a small business corporation, and (4) the corporation and each person who was a
shareholder of the corporation at any time during the period specified pursuant to
§ 1362(f), agrees to make any adjustments (consistent with the treatment of the
corporation as an S corporation) as may be required by the Secretary with respect to
the period, then, notwithstanding the circumstances resulting in the termination, the
corporation will be treated as continuing to be an S corporation during the period
specified by the Secretary.

      Section 1.1362-4(d) of the Income Tax Regulations provides that the
Commissioner may require any adjustments that are appropriate. In general, the
adjustments required should be consistent with the treatment of the corporation as an S
corporation during the period specified by the Commissioner.

CONCLUSION

       Based solely on the facts submitted and the representations made, we conclude
that X’s S election terminated on Date 3 because of the failure to timely file an ESBT
election for Trust 2. 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 3 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: 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; and (2) An election to treat Trust 2 as an ESBT effective Date
3 must be made with the appropriate service center. A copy of this letter should be
attached to the ESBT election.

       Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. Specifically, no opinion is expressed concerning whether X is
otherwise eligible to be treated as an S corporation, or whether Trust 2 is eligible to be
treated as an ESBT.

PLR-115705-17                                 5

      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.

        Pursuant to the power of attorney on file with this office, we are sending a copy of
this letter to X’s 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 § 6110 purposes

cc: