S status preserved after trust missed its ESBT election

Plain-English summary

A grantor trust held stock in an S corporation. After the grantor died, the trustee intended the trust to remain an eligible shareholder but failed to make a timely electing small business trust election. The trust became ineligible and the corporation's S election terminated. The corporation represented that the termination was inadvertent, was not motivated by tax avoidance or retroactive planning, and that the trust otherwise met the ESBT requirements. The IRS treated the corporation as continuing to be an S corporation. Relief required a specified adjustment payment, a retroactive ESBT election, and all necessary consistent returns by a redacted deadline, and it would be void if those conditions were not met.

Ruling snapshot

• Question: Could the corporation retain S status after a shareholder trust missed its ESBT election following the grantor's death?
• Outcome: Approved, conditioned on a specified payment, the ESBT election, and consistent returns by the stated deadline.
• Key authorities: IRC §§ 1361(e) and 1362(f); Treas. Reg. § 1.1361-1(m)(2)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201824002                                              Third Party Communication: None
Release Date: 6/15/2018                                        Date of Communication: Not Applicable
Index Number: 1361.03-03, 1362.02-02,
              1362.04-00                                       Person To Contact:
                                                               -------------------, ID No. ------------------
-----------------------------------                            Telephone Number:
----------------------------                                   ----------------------
--------------------------------------------------------       Refer Reply To:
----------------------------------                             CC:PSI:B01
                                                               PLR-114235-17
                                                               Date:
                                                               October 27, 2017


LEGEND

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

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

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

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

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

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

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

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

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

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

$a       =         --------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
PLR-114235-17                               2



Dear --------------

This responds to a letter dated March 31, 2017, and supplemental information,
submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

FACTS

According to the information submitted and representations within, X was incorporated
on Date 1, under the laws of State. Effective Date 1, X elected to be taxed as an S
corporation. On Date 2, A created a grantor trust, Trust, which was an eligible
shareholder of X. On Date 3, A died. It was intended that Trust remain an eligible
shareholder of X after the death of A. However, as of Date 4, an Electing Small
Business Trust (ESBT) election was not timely filed for Trust thereby causing Trust to
become an ineligible shareholder of X. As a result, X’s S corporation election
terminated on Date 4.

X represents that Trust as of Date 4 and thereafter met the requirements of an ESBT
within the meaning of § 1361(e). 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) of the Code 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 § 1362(b)(1)(B), an electing
small business trust (ESBT) may be an S corporation shareholder.

Section 1361(e) 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
PLR-114235-17                                 3

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(f) provides, in relevant part, that if (1) an election under § 1362(a) by any
corporation was not effective for the taxable year for which made (determined without
regard to § 1362(b)(2)) by reason of a failure to meet the requirements of § 1361(b) or
was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that the
circumstances resulting in such ineffectiveness or 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 so that the corporation for which
the election was made or termination occurred is a small business corporation; and (4)
the corporation for which the election was made or 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
ineffectiveness or 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 election inadvertently terminated within the meaning of § 1362(f) on Date 4 when
PLR-114235-17                                4

Trust became an ineligible shareholder. Pursuant to the provisions of § 1362(f), X will
be treated as an S corporation from Date 4 and thereafter, provided X’s S corporation
election is not otherwise terminated under § 1362(d).

This letter ruling is subject to the following conditions. No later than Date 5: (1) an
adjustment payment in the amount of $a for Years and a copy of this letter ruling 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; (2) an election to treat Trust as an ESBT effective Date 4, must be made with
the appropriate service center; and (3) X and each of its shareholders must file any
original and amended returns for all open taxable years consistent with the relief
granted in this letter. 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.

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.

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

                                      Sincerely,


                                      Faith P. Colson
                                      Faith P. Colson
                                      Senior Counsel, Branch 1
                                      Office of the Chief Counsel
                                      (Passthroughs & Special Industries)



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