Modified ruling preserves S status after a missed ESBT election

Plain-English summary

Shareholders transferred S corporation stock to an irrevocable trust that was eligible to be an electing small business trust, but the trustee did not timely make the ESBT election. The missed election terminated the corporation's S status. The IRS found that the termination was inadvertent and ruled that the corporation would continue to be treated as an S corporation and the trust as an ESBT from the transfer date. The trust and its beneficiaries had 60 days to file the election and consistent amended returns. This modified ruling also required a redacted adjustment payment by a specified date and superseded an earlier ruling.

Ruling snapshot

• Question: Can the corporation retain S status despite the trustee's failure to timely elect ESBT treatment?
• Outcome: approved, conditioned on a late ESBT election, consistent amended returns, and an adjustment payment
• Key authorities: IRC §§ 1361(e), 1362(f), 1366-1368; Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201934001                                            Third Party Communication: None
Release Date: 8/23/2019                                      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-110240-19
                                                             Date:
                                                             May 16, 2019
         LEGEND

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

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

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

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

 B               = ---------------------------------------
                   ---------------------------------------
 n               = ---------



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

       This letter is being sent to modify out private letter ruling (PLR 2001910014)
dated December 6, 2018 (the “PLR”). We are modifying the PLR to include language
under the heading CONCLUSION stating that as an adjustment under § 1362(f), a
payment is due, and the mailing and payment requirements associated with the
adjustment payment. The PLR contains a ruling under § 1362(f) of the Internal
Revenue Code (the Code). This ruling modifies and supersedes the PLR.

         The PLR, as modified, reads as follows:

                                           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.

       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      § 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.

         Furthermore, as an adjustment under § 1362(f), a payment of $n and a copy of
this letter ruling 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

       The payment of this letter must be sent no later than Date 3.

       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.

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