Late ESBT elections receive inadvertent-termination relief

Plain-English summary

An S corporation's stock was held by two grantor trusts. When each trust later stopped being a grantor trust, its trustee failed to make a timely electing small business trust election, causing the corporation's S election to terminate when the first trust changed status and creating a second potential termination when the other trust changed. The corporation represented that the failures were inadvertent, were not motivated by tax avoidance, and that it continued filing consistently as an S corporation. The IRS granted inadvertent-termination relief and treated the corporation as continuing its S status. Relief requires each trustee to file an ESBT election effective on the relevant trust's status-change date within 120 days.

Ruling snapshot

• Question: Could the corporation retain S status after two trusts failed to make timely ESBT elections when they ceased being grantor trusts?
• Outcome: Approved, conditioned on both corrective ESBT elections within 120 days.
• Key authorities: IRC §§ 1361(e) and 1362(f); Treas. Reg. § 1.1361-1(m)(2).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201947011 Third Party Communication: None
Release Date: 11/22/2019 Date of Communication: Not Applicable
Index Numbers: 1361.00-00, 1361.03-00,
1361.03-03, 1362.00-00, Person To Contact:
1362.02-00, 1362.02-02, ----------------------, ID No. ------------------
1362.04-00 Telephone Number:
----------------------
----------------------------- Refer Reply To:
--------------------------------------------- CC:PSI:B03
------------------------------ PLR-106196-19
------------------------------------- Date:
August 22, 2019

LEGEND

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

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

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

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

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

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

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

Date 4 = ------------------

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

Dear -----------------:
PLR-106196-19 2

This responds to a letter dated March 7, 2019, and subsequent correspondence
submitted on behalf of X, requesting inadvertent termination relief under § 1362(f) of the
Internal Revenue Code.

                                     FACTS

The information submitted states that X was incorporated under the laws of State on
Date 1, and elected to be an S corporation effective Date 2.

On Date 2, A transferred X stock to Trust 1 and Trust 2. X represents that Trust 1 and
Trust 2 were treated as a wholly-owned grantor trusts under §§ 671 and 676.

On Date 3, Trust 1 ceased to be a grantor trust with respect to A’s interests. On Date 4,
Trust 2 ceased to be a grantor trust with respect to A’s interests.

X represents that Trust 1 and Trust 2 qualified to elect to be treated as electing small
business trusts (ESBTs), however, the trustee failed to make timely ESBT elections
within the meaning of § 1361(e)(1)(A)(v). Consequently, X’s S corporation election
terminated on Date 3 when the trustee failed to make an ESBT election for Trust 1. The
failure to make the ESBT election for Trust 2 on Date 4, would have terminated X’s S
corporation election had it not already been terminated Date 3.

X represents that the circumstances resulting in the termination of their respective S
corporation elections were inadvertent and not motivated by tax avoidance. X further
represent that it filed returns consistent with its status as an S corporation. X and its
shareholders agree to make such adjustments (consistent with the treatment of X 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.
PLR-106196-19 3

Section 1361(c)(2)(A)(v) provides that for the purposes of § 1362(b)(1)(B), an 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 section 170(c)(2), (3), (4) or (b) 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)(1)(B) provides that the term ESBT does 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 election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 1st 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
PLR-106196-19 4

(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.

                                  CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X’s S
corporation election terminated beginning on Date 3, when Trust 1 ceased to be a
grantor trust, because the trustee of Trust 1 failed to timely file the ESBT election under
§ 1361(e)(1)(A)(v). We conclude that the termination was inadvertent within the
meaning of § 1362(f). Moreover, had X’s S corporation election not already terminated
on Date 3, it would have terminated on Date 4, when Trust 2 ceased to be a grantor
trust, and the trustee of Trust 2 failed to a timely file the ESBT election under
§ 1361(e)(1)(A)(v). Similarly, this termination would have been inadvertent within the
meaning of § 1362(f).

Pursuant to the provisions of § 1362(f), X will be treated as an S corporation on and
after Date 3, unless X’s S corporation election is otherwise terminated under § 1362(d).
This ruling is conditioned on (1) the trustee of Trust 1 filing an ESBT election effective
Date 3, with the appropriate service center within 120 days of the date of this letter, and
2) the trustee of Trust 2 filing an ESBT election for Trust 2 effective Date 4, within 120
days from the date of this letter. A copy of this letter should be attached the ESBT
elections.

Specifically, we express or imply no opinion regarding whether X is otherwise eligible to
be treated as an S corporation or whether Trust 1 and Trust 2 are eligible to be treated
as ESBTs.

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.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.
PLR-106196-19 5

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

                                        Sincerely,



                                         Stacy L. Short
                                         Senior Technician Reviewer, Branch 3
                                         Office of the Associate Chief Counsel
                                         (Passthroughs & Special Industries)

Enclosures: Copy of this letter
Copy of this letter for § 6110 purpose

cc: