S-corporation status preserved after five trusts missed their ESBT elections

Plain-English summary

An S corporation may only be owned by certain kinds of shareholders. When a trust receives S-corporation shares, it generally must file an "electing small business trust" (ESBT) election to remain a permitted owner; if it does not, the company's S-corporation status can terminate. Here shares were transferred to five trusts, but none of the trustees filed the required ESBT elections, which technically ended the company's S election on the transfer date, even though the company and everyone involved kept treating it as an S corporation and the trusts filed their returns as ESBTs. The company asked the IRS for relief under Internal Revenue Code § 1362(f), which lets the IRS disregard such a termination when it was inadvertent, promptly corrected, and everyone agrees to any needed adjustments. The IRS found the failure inadvertent and ruled the company will be treated as continuing to be an S corporation, on the condition that all five trusts file their ESBT elections within 120 days. This is routine cleanup relief that preserves the pass-through tax treatment the business relied on. The IRS expressed no opinion on whether the company otherwise qualifies as an S corporation or whether the trusts otherwise qualify as ESBTs.

Ruling snapshot

• Question: Was the termination of the company's S election (caused by five trusts missing their ESBT elections) inadvertent, so that § 1362(f) relief applies?
• Outcome: Approved (S status treated as continuing, contingent on filing the five ESBT elections within 120 days)
• Key authorities: IRC §§ 1362(f), 1362(d), 1361(b), 1361(c)(2), 1361(e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201845005                                             Third Party Communication: None
Release Date: 11/9/2018                                       Date of Communication: Not Applicable
Index Number: 1362.04-00, 1361.01-02
                                                              Person To Contact:
---------------------------------------                       ----------------------ID No. -------------
-----------------------------                                 Telephone Number:
-----------------------------------------                     --------------------
--------------------------------                              Refer Reply To:
                                                              CC:PSI:B01
                                                              PLR-102614-18
                                                              Date:
                                                              July 27, 2018




LEGEND:

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

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

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

Trust 3        =       ------------------------------------------------------------------------------------------------------------
                       ---------------------------------

Trust 4        =       ------------------------------------------------------------------------------------------------------------
                       --------------------------------

Trust 5        =       ------------------------------------------------------------------------------------------------------------
                       -----------------------------

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

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

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

Date 3         =       --------------------------
PLR-102614-18                                 2

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

This responds to a letter dated December 4, 2017, and subsequent information,
submitted on behalf of X by its authorized representative, requesting a ruling under
§ 1362(f) of the Internal Revenue Code.

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 2. On Date 3,
shares of X stock were transferred to Trust 1, Trust 2, Trust 3, Trust 4, and Trust 5
ineligible S corporation shareholders.

X represents that Trust 1, Trust 2, Trust 3, Trust 4, and Trust 5 each meet the
requirements to be treated as an Electing Small Business Trusts (ESBT), within the
meaning of § 1361(e). However, no election was made under § 1361(e)(3) to treat Trust
1, Trust 2, Trust 3, Trust 4, and Trust 5 as ESBTs effective Date 3.

X represents that X and its shareholders have treated X as an S corporation at all
relevant times. X further represents that Trust 1, Trust 2, Trust 3, Trust 4 and Trust 5
have each filed their income tax returns consistent with being an ESBT.

X represents that the failure to file ESBT elections for Trust 1, Trust 2, Trust 3, Trust 4,
and Trust 5 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 (consistent with the treatment of X as an S corporation) 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
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 may
be an S corporation shareholder.
PLR-102614-18                                 3

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)(1)(B) provides that an ESBT does 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) 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(f) provides 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 the
termination, steps were taken so that the corporation is 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 under § 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 for that 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 facts submitted and representation made, we conclude X's S
election terminated on Date 3 upon the failure to timely file ESBT elections for Trust 1,
PLR-102614-18                                 4

Trust 2, Trust 3, Trust 4, and Trust 5. We further conclude that the termination was
inadvertent within the meaning of § 1362(f).

Accordingly, under § 1362(f), X will be treated as continuing to be an S corporation from
Date 3 and thereafter, provided that X's S election is valid and not otherwise terminated
under § 1362(d).

This letter ruling is subject to the condition that within 120 days from the date of this
letter, an election to treat each Trust 1, Trust 2, Trust 3, Trust 4, and Trust 5 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. If this condition is not met, then this
ruling is null and void.

Except as specifically ruled above, we express or imply no opinion concerning the
federal tax consequences of the transactions described above under any other
provision of the Code. Specifically, we express or imply no opinion regarding whether X
is otherwise eligible to be an S corporation or whether Trust 1, Trust 2, Trust 3, Trust 4,
and Trust 5 are eligible to be treated as ESBTs.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
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 X's authorized
representative.



                                      Sincerely,

                                      Laura C. Fields

                                      Laura C. Fields
                                      Senior Technician Reviewer, Branch 1
                                      (Passthroughs & Special Industries)



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


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