S corporation received inadvertent-termination relief after trust merger

Plain-English summary

An eligible electing small business trust that owned S corporation shares merged into a second trust. The surviving trust filed an ESBT election using a later effective date than the actual share transfer, causing the corporation’s S election to terminate when the surviving trust became an ineligible shareholder. The IRS found the termination inadvertent and allowed the corporation to remain an S corporation, conditioned on the surviving trustee filing an ESBT election effective on the actual merger date within 120 days.

Ruling snapshot

• Question: May an S corporation receive inadvertent-termination relief when a trust merger transferred its shares before the surviving trust’s stated ESBT election date?
• Outcome: approved, conditioned on filing a corrected ESBT election within 120 days
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. §§ 1.1361-1(m) and 1.1362-4(d)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201941007                                             Third Party Communication: None
Release Date: 10/11/2019                                      Date of Communication: Not Applicable
Index Number: 1362.04-00
                                                              Person To Contact:
---------------------------------------                       ---------------------, ID No. ------------------
----------------------------------------------                Telephone Number:
------------------------------------                          ----------------------
-----------------------------                                 Refer Reply To:
                                                              CC:PSI:B03
                                                              PLR-101935-19
                                                              Date:
                                                              July 12, 2019




Legend

Trust 1           =         ----------------------------------------------------------------------------------------
                            ------------------------------------
Trust 2           =         ----------------------------------------------------------------------------------------
                            ------------------------------
A                 =         ----------------------------------------------------------------------------------------
                            --------------------------------------
Date 1            =         --------------------
Date 2            =         ----------------------------
Date 3            =         ------------------
Date 4            =         --------------------
Date 5            =         -------------------
State             =         --------------

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

       This letter responds to a letter dated February 5, 2019 submitted on behalf of A,
by A’s authorized representatives, requesting inadvertent termination relief under
§ 1362(f) of the Internal Revenue Code.

                                                      Facts

        A was incorporated under the laws of State and elected to be an S corporation
effective Date 1.

       On Date 2, Trust 1 acquired shares in A. Trust 1 qualified under
§ 1362(c)(2)(A)(v) as an eligible S corporation shareholder and timely filed an ESBT
election effective Date 2. A represents that on Date 3, under the laws of State Trust 1
merged with and into Trust 2, with Trust 2 surviving. As a result of the merger, the
shares of A owned by Trust 1 were transferred to Trust 2 as of Date 3.

PLR-101935-19                                 2


       On Date 4, the trustee of Trust 2 filed an election under § 1362(c)(2)(A)(v) to be
treated as an ESBT effective Date 5. The ESBT election incorrectly stated that the
shares of A owned by Trust 1 prior to the merger were transferred to Trust 2 on Date 5,
when the shares were actually transferred on Date 3. A represents that Trust 2
intended the ESBT election to be effective as of Date 3. As a result, A’s S corporation
election terminated on Date 3 because Trust 2 was an ineligible shareholder.

      A represents that the circumstances resulting in the termination of A’s S
corporation election were inadvertent and not motivated by tax avoidance. A further
represents that A filed returns consistent with A’s status as an S corporation. A and its
shareholders agree to make such adjustments consistent with the treatment of A as an
S corporation as 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)(B) provides that, for purposes of subchapter S, 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, for purposes of § 1361(b)(1)(B), a trust all
of which is treated (under subpart E of part 1 of subchapter J of chapter 1) as owned by
an individual who is a citizen or resident of the United States may be an S corporation
shareholder.

       Section 1361(c)(2)(A)(v) provides that for the purposes of § 1362(b)(1)(B), an
electing small business trust may be a shareholder.

         Section 1361(e)(1)(A) provides that for purposes of § 1361, except as provided in
§ 1361(e)(1)(B), the term “electing small business trust” 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 made by the
trustee. Any such election shall apply to the taxable year of the trust for which made

PLR-101935-19                                 3

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, in part, that
the trustee of the trust 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(d)(2)(A) provides that an election under § 1362(a) shall 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 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 such
termination, steps were taken so that the corporation for which the termination occurred
is a small business corporation, and (4) the corporation for which the 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 such 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 termination, such corporation shall be treated as an
S corporation during the period specified by the Secretary.

       Section 1.1362-4(d) provides, in part, that the Commissioner may require any
adjustments that are appropriate. In general, the adjustments should be consistent with
the treatment of the corporation as an S corporation during the period specified by the
Commissioner.

                                            Conclusion

       Based solely on the facts submitted and representations made, we conclude that
the S corporation election for A terminated on Date 3 when the shares of Trust 1 were
transferred to Trust 2. We further conclude that the termination was inadvertent within
the meaning of § 1362(f) and A will continue to be treated as an S corporation for the
period from Date 1 provided that the S corporation election for A was valid and was not
otherwise terminated under § 1362(d).

        This ruling is conditioned upon the trustee of Trust 2 filing an ESBT election
effective Date 3. The election must be filed with the appropriate service center within
120 days of the date of this ruling. A copy of this letter should be attached to the ESBT
election.

PLR-101935-19                                  4


        Except as expressly provided herein, we express or imply no opinion concerning
the tax consequences of any aspect of any transaction or item discussed or referenced
in this letter. Specifically, we express or imply no opinion regarding whether A is
otherwise eligible to be treated as an S corporation or whether Trust 2 is eligible to be
treated as an ESBT. Further, we express or imply no opinion concerning the validity or
tax consequences of the merger of Trust 1 and Trust 2.

      This ruling is directed only to the taxpayers requesting it. Section 6110(k)(3) of
the Code 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 A’s authorized representatives.


                                        Sincerely,


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

Enclosures (2)
      Copy of Letter
      Copy for 6110 purposes


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