An S corporation's accidental termination is forgiven after a trust missed its ESBT election

Plain-English summary

An S corporation can only have certain kinds of shareholders. A trust is an eligible shareholder only if it fits one of the permitted categories, and one common way is for the trust to elect to be an "electing small business trust" (ESBT), an election the trustee must file. Here an S corporation's shares were transferred to an irrevocable trust, and although the trust was eligible to be an ESBT, the trustee never filed the ESBT election. Because the trust held the shares without a valid election, the corporation had an ineligible shareholder and its S corporation status automatically terminated on the transfer date. The company represented that the missed election was inadvertent and not tax-motivated, and that it had kept filing as an S corporation. Section 1362(f) lets the IRS forgive an inadvertent termination and treat the company as having stayed an S corporation, provided corrective steps are taken. The IRS ruled the termination was inadvertent, that the company will be treated as an S corporation continuously from the termination date, and that the trust will be treated as an ESBT from that date, conditioned on the trustee filing a proper ESBT election and the trust and its beneficiaries filing amended returns within 60 days. This restores the company's pass-through tax status despite the trustee's oversight.

Ruling snapshot

• Question: Was the S corporation's termination (caused by a trust's missed ESBT election) inadvertent, so the company can be treated as remaining an S corporation under section 1362(f)?
• Outcome: approved (inadvertent termination relief granted; trust treated as an ESBT, contingent on filing the election and amended returns within 60 days)
• Key authorities: IRC §§ 1362(f), 1361(c)(2), 1361(e) (ESBT); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201910014                                            Third Party Communication: None
Release Date: 3/8/2019                                       Date of Communication: Not Applicable
                                                             Person To Contact:
Index Number: 1362.04-00, 1361.03-03                         --------------------------, ID No. ---------------
                                                             -----------------
---------------------------------------------------          Telephone Number:
----------------------                                       ---------------------
----------------------------                                 Refer Reply To:
--------------------------------                             CC:PSI:B03
                                                             PLR-124807-18
                                                             Date:
                                                             December 06, 2018


         LEGEND

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

 Date 1          = ----------------
 Date 2          = ---------------------------

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

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

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



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

       This responds to a letter dated July 26, 2018 submitted on behalf of X by its
authorized representative requesting a ruling under § 1362(f) of the Internal Revenue
Code (the Code).

                                                      FACTS

       Effective Date 1, X elected to be treated as an S corporation. On Date 2, A and B
transferred shares of X to Trust, an irrevocable trust created by A and B. It is
represented that Trust is eligible to be an electing small business trust (ESBT) under
§ 1361(e). However, the trustee of Trust did not file a timely ESBT election for Trust
and X’s S corporation election terminated on Date 2.
PLR-124807-18                                   2

       X represents the failure to file the ESBT election for Trust was inadvertent and
was not motivated by tax avoidance or retroactive planning. X has filed all returns
consistent with X’s status as an S corporation since Date 2. X and its shareholders
agree to make any adjustments required as a condition of obtaining relief under the
inadvertent termination rule as provided in § 1362(f) of the Code.

                                    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)(B) provides that the term “small business corporation” means a
domestic corporation which is not an ineligible corporation and which does not 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.

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 is an eligible shareholder. Section 1361(c)(2)(A)(ii)
provides that a trust which was described in § 1361(c)(2)(A)(i) immediately before the
death of the deemed owner and which continues in existence after such death is an
eligible shareholder, but only for the 2-year period beginning on the day of the deemed
owner’s death. Section 1361(c)(2)(A)(v) provides that an ESBT is an eligible
shareholder.

Section 1361(e)(1)(A) provides that, except as provided in § 1362(e)(2)(B), 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.

Section 1.1361-1(m)(2)(i) provides that the trustee of the 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(f) provides that if (1) an election under § 1362(a) by any corporation (A)
was not effective for the taxable year for which made (determined without regard to
PLR-124807-18                                  3

§ 1362(b)(2)) by reason of a failure to meet the requirements of § 1361(b) or to obtain
shareholder consents or (B) was terminated under § 1362(d)(2) or (3), (2) the Secretary
determines that the circumstances resulting in the ineffectiveness or termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in the ineffectiveness or termination, steps were taken (A) so
that the corporation is a small business corporation or (B) to acquire the shareholder
consents; 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 such adjustments (consistent with the treatment of the corporation as an S
corporation) as may be required by the Secretary with respect to such period, then,
notwithstanding the circumstances resulting in the ineffectiveness or termination, the
corporation will be treated as an S corporation during the period specified by the
Secretary.

                                       CONCLUSION

Based solely on the facts and representations submitted, we conclude that X’s S
corporation election was terminated on Date 2 because trustee of Trust failed to file an
ESBT election for Trust, and that this termination was inadvertent within the meaning of
§ 1362(f).

We hold that, pursuant to the provisions of § 1362(f), X will be treated as an S
corporation from Date 2, and thereafter, provided X was otherwise eligible to make an S
corporation election and provided that any such election would not have otherwise been
terminated under § 1361(d). Trust will be treated as an ESBT effective Date 2. The
shareholders of X must include their pro-rata share of the separately stated and
nonseparately computed items of X as provided in § 1366, make any adjustments to
basis as provided in § 1367, and take into account any distributions made by X as
provided in § 1368. If X or its shareholders fail to treat themselves as described above,
this ruling is null and void.

This ruling is conditioned upon the trustee of Trust filing an appropriately completed
ESBT election for Trust effective Date 2, and upon Trust and its beneficiaries filing
timely amended federal income tax returns consistent with the treatment of Trust as an
ESBT effective Date 2. The election must be made and the amended returns must be
timely filed within 60 days following the date of this letter and a copy of this letter should
be attached to the election and the returns.

Except as specifically ruled above, we express no opinion concerning the federal tax
consequences of the transactions described above under any other provisions of the
Code.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.
PLR-124807-18                                 4

Pursuant to a power of attorney on file, a copy of this letter is being sent to X’s
authorized representative.

                                              Sincerely,




                                              Richard T. Probst
                                              Senior Technician Reviewer, Branch 3
                                              Associate Chief Counsel
                                              (Passthroughs and Special Industries)


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