Late ESBT elections caused an inadvertent S termination

Plain-English summary

An S corporation shareholder held stock through a revocable grantor trust. At the shareholder's death, the stock passed to two successor trusts that qualified as electing small business trusts, but their ESBT elections were not filed on time, causing the corporation's S election to terminate. The parties later filed ESBT elections, consistently reported the corporation and trusts as retaining their intended tax status, and represented that the error was inadvertent rather than tax-motivated. The IRS granted section 1362(f) relief so the corporation would be treated as continuously maintaining its S status, conditioned on a redacted payment and the stated filing requirements.

Ruling snapshot

• Question: Could an S corporation obtain inadvertent-termination relief after two successor trusts failed to make timely ESBT elections?
• Outcome: Yes; continuous S corporation treatment was granted subject to the required payment and conditions.
• Key authorities: IRC §§ 1361(e) and 1362(f)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201925003                                              Third Party Communication: None
Release Date: 6/21/2019                                        Date of Communication: Not Applicable
Index Number: 1361.05-00, 1362.00-00,
              1362.04-00, 9100.31-00                           Person To Contact:
                                                               -------------------------, ID No. -----------------
--------------------------------                               -----------------------------------------------------
--------------------------------------------------------       Telephone Number:
------------------------------------------                     ----------------------
------------------------------------------                     Refer Reply To:
                                                               CC:PSI:B03
                                                               PLR-121148-18
                                                               Date:
                                                               March 13, 2019


LEGEND

X                 =         --------------------------------
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A                 =        ----------------------------

Trust1            =         -----------------------------------------------------------------------
------------------------------------------------------------------------
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Trust2            =         ------------------------------------------------------------------------
                           --------------------------
                           ------------------------------
                           ------------------------

Trust3            =         -----------------------------------------------------------------------------------------
-----------------------------------------------------
---------------------------------------------------------
---------------------------------------------------

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

Date1             =        --------------------------

Date2             =        ----------------------

Date3             =        ---------------------

Date4             =        -----------------
PLR-121148-18                                2


Date5           =      -----------------

Date6           =      -------------------

N1              =      ----

N2              =      ------

N3              =      ----

N4              =      ------------


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

      This responds to a letter dated July 2, 2018, and subsequent correspondence,
submitted on behalf of X by X’s authorized representative, requesting a ruling under
§1362(f) of the Internal Revenue Code (the Code).

        The information submitted states that X was incorporated under the laws of State
on Date1. X elected to be taxed as an S corporation effective on Date2. At the time of
X’s S corporation election, A owned N1% of X’s stock. On Date3, A transferred A’s
shares in X to Trust1. Trust1 was a revocable trust and was properly treated as a
grantor trust for purposes of § 671 of the Code from Date3 until Date4, when A died.
Upon A’s death, the shares of X held in Trust1 were transferred to Trust2 and Trust3.
After this transfer, Trust2 owned N2% and Trust3 owned N3% of X stock.

       X further represents that Trust2 and Trust3 meet the requirements of
§ 1361(e)(1)(A) to be Electing Small Business Trusts (ESBTs), except that ESBT
elections were not timely made on behalf of Trust2 and Trust3 at the time the stock of X
was transferred to Trust2 and Trust3 upon A’s death on Date4. Accordingly, the S
corporation election of X terminated on the date of this transfer, because Trust2 and
Trust3 were ineligible S corporation shareholders of X at that time. X represents that
Trust2 and Trust3 subsequently made elections to be treated as ESBTs effective on
Date5.

       X represents that X and all of X’s shareholders have filed tax returns consistent
with X being an S corporation since Date4. In addition, X represents that Trust2 and
Trust3 have filed tax returns consistent with their treatment as ESBTs since Date5. X
further represents that the circumstances resulting in the termination of X’s S
corporation election were inadvertent and were not motivated by tax avoidance or
retroactive tax planning. X and its shareholders have agreed to make adjustments
PLR-121148-18                                3

consistent with the treatment of X as an S corporation, and Trust2 and Trust3 as ESBTs
beginning Date4, as may be required by the Secretary.

       Section 1362(f) provides that if (1) an election under § 1362(a) by a corporation
(A) 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 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.

        Based solely on the facts submitted and the representations made, we conclude
that X’s S corporation election terminated on Date4, or thereafter, as the result of the
failure of the trustees of Trust2 and Trust3 to make elections under § 1361(e)(3) to treat
Trust2 and Trust3 as ESBTs effective as of the date of the transfer of X stock to Trust2
and Trust3. We further conclude that the termination of X’s S corporation election on
Date4, or thereafter, was inadvertent within the meaning of § 1362(f). We further hold
that, pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation from Date4 and thereafter, provided that X’s S corporation election was
valid and provided that the election was not otherwise terminated under § 1362(d).

        Furthermore, as an adjustment under § 1362(f)(4), a payment of $N4 and a copy
of this letter must be sent to the following address: Internal Revenue Service, Kansas
City Service Center, 333 Pershing Road, Kansas City, MO 64108, Stop 7777, Manual
Deposit. This payment and a copy of this letter must be sent no later than Date6.

        Except as specifically set forth above, no opinion is expressed concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed regarding X’s eligibility to be an S
corporation. In addition, no opinion is expressed as to whether Trust2 and Trust3 are
eligible to elect to be treated as ESBTs.

       This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
of the Code provides that it may not be used or cited as precedent.
PLR-121148-18                               4

      In accordance with the power of attorney on file with this office, we are sending
copies of this letter to X’s authorized representatives.

                                     Sincerely,



                                     Adrienne M. Mikolashek
                                     Branch Chief, Branch 3
                                     Office of Associate Chief Counsel
                                     (Passthroughs & Special Industries)


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



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