S election saved after three shareholder trusts failed to make timely ESBT elections

Plain-English summary

A corporation elected S status, but three trusts that held its stock never
filed the Electing Small Business Trust (ESBT) elections they needed to be
eligible shareholders. Because those trusts were technically ineligible
owners from day one, the company's S election was never effective. The
company asked the IRS for relief under Section 1362(f), representing that
the trusts otherwise qualified as ESBTs, that everyone had treated the
company as an S corporation all along, and that they would fix the paperwork.
The IRS found the defect inadvertent and ruled the company is treated as an
S corporation from the original effective date, subject to three conditions:
making a specified adjustment payment, filing the late ESBT elections within
120 days, and filing any needed original or amended returns treating the
trusts as ESBTs. Owners who hold S corporation stock through trusts care
because forgetting the ESBT election can retroactively void the company's
pass-through status.

Ruling snapshot

• Question: Was the S election's ineffectiveness (three trusts that skipped their ESBT elections) inadvertent and curable under § 1362(f)?
• Outcome: Approved (relief granted, subject to an adjustment payment, late ESBT elections, and amended returns)
• Key authorities: IRC § 1362(f); IRC § 1361(b)(1), (c)(2)(A)(v), (e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201918002 Third Party Communication: None
Release Date: 5/3/2019 Date of Communication: Not Applicable
Index Number: 1361.01-00, 1361.01-02,
1361.03-00, 1361.03-03, Person To Contact:
1362.00-00, 1362.01-00, ----------, ID No. ----------
1362.04-00 Telephone Number:
----------
---------- Refer Reply To:
---------- CC:PSI:01
---------- PLR-118012-18
---------- Date:
October 15, 2018

LEGEND

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

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

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

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

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

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

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

Years 1 = ----------

Years 2 = ----------

a% = ----------
PLR-118012-18 2

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

This responds to a letter dated May 31, 2018, and supplemental information, submitted
on behalf of X by X's authorized representatives, 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 2, X elected to be taxed as an S
corporation. However, an Electing Small Business Trust (ESBT) election effective
Date 2 was not timely filed for Trust 1, Trust 2, and Trust 3, shareholders of X.
Accordingly, Trust 1, Trust 2, and Trust 3 were ineligible shareholders of X and X's S
corporation election was ineffective.

X represents that Trust 1, Trust 2 and Trust 3 have at all times met the requirements of
an ESBT within the meaning of § 1361(d)(3), except that the trustees of Trust 1, Trust 2,
and Trust 3 did not make timely ESBT elections under § 1361(e)(3). X further
represents that Trust 1, Trust 2, and Trust 3 have not filed their income tax returns
consistent with being ESBTs for Years 1.

X represents that, other than the failure to make valid ESBT elections by Date 2, X has
qualified as a small business corporation at all times since its election on Date 2. X
further represents that X and its shareholders have treated X as an S corporation at all
relevant times. In addition, X represents that X has filed its income tax returns
consistent with having a valid S election in effect for all taxable years since X elected to
be an S corporation.

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) 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
PLR-118012-18 3

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
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) provides that an S corporation election will 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 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
PLR-118012-18 4

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 was inadvertently ineffective within the meaning of § 1362(f) on Date 2
because Trust 1, Trust 2, and Trust 3 were ineligible shareholders of X. Pursuant to the
provisions of § 1362(f), X will be treated as an S corporation from Date 2 and thereafter,
provided X's S corporation election is otherwise effective and not terminated under
§ 1362(d).

This letter ruling is subject to the following conditions: (1) Within 120 days from the date
of this letter, an adjustment payment in the amount of $a and a copy of this letter must
be sent to the following address: Internal Revenue Service, Kansas City Service
Center; 333 W. Pershing Road, Kansas City, MO 64108, Stop 7777, Manual Deposit ;
(2) within 120 days from the date of this letter, an election to treat Trust 1, Trust 2, and
Trust 3 as an ESBT effective Date 2 must be made with the appropriate service center;
and (3) X and its shareholders filing any necessary original or amended returns
consistent with the relief granted in this letter within 120 days of this letter, including but
not limited to income tax returns for Years 2 reflecting the treatment of Trust 1, Trust 2,
and Trust 3 as ESBTs. A copy of this letter should be attached to the ESBT elections
and any amended returns. If these conditions are not met, then this letter ruling is null
and void. Furthermore, if these conditions are not met, X must send notification that its
S election has terminated to the service center with which X’s S 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.

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.
PLR-118012-18 5

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

                                             Sincerely,



                                             Wendy L. Kribell
                                             Assistant to the Branch Chief, Branch 1
                                             Office of the Associate Chief Counsel
                                             (Passthroughs and Special Industries)

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