Late trust elections treated as an inadvertent S corporation termination

Plain-English summary

An S corporation transferred shares to three trusts that were eligible to elect treatment as electing small business trusts, but the trustees did not file timely elections. The missed filings made the trusts ineligible shareholders and terminated the corporation's S election. The IRS found the termination inadvertent because the corporation otherwise remained eligible, consistently reported as an S corporation, and did not act for tax avoidance or retroactive planning. The corporation may continue to be treated as an S corporation if each trustee files an election effective on the original transfer date and all required returns are filed or amended within 120 days.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after three trusts failed to file timely ESBT elections?
• Outcome: Approved, subject to corrective elections and returns 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: 201948008 Third Party Communication: None
Release Date: 11/29/2019 Date of Communication: Not Applicable
Index Number: 1361.03-03, 1362.01-00,
1362.04-00 Person To Contact:
-------------------, ID No. ------------
------------------------------------- Telephone Number:
--------------- --------------------
-------------------------- Refer Reply To:
---------------------- CC:PSI:B03
PLR-103694-19
Date:
August 29, 2019

LEGEND

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

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

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

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

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

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

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

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

   This responds to a letter dated January 10, 2019, submitted on behalf of X by its

authorized representatives, requesting a ruling 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 that X elected to be an S corporation effective on the same date. On
Date 2, shares of X were transferred to Trust 1, Trust 2 and Trust 3 (together, “the

PLR-103694-19 2

Trusts”). X represents that the Trusts were eligible to be treated as Electing Small
Business Trusts (ESBTs) under § 1361(e). However, ESBT elections effective Date 2
were not timely filed for the Trusts. Accordingly, each of the three Trusts was an
ineligible shareholder of X, with the result that X's S corporation election terminated on
Date 2.

    X represents that, other than the failure to timely file valid ESBT elections, X has

qualified as a small business corporation at all times since Date 2. X further represents
that X and its shareholders have treated X as an S corporation at all relevant times on
all relevant returns. X additionally represents that its S corporation election termination
was inadvertent and was not motivated by tax avoidance or retroactive tax planning. X
and its shareholders have agreed to make any adjustments that the Commissioner may
require, consistent with the treatment of X as an S corporation.

                              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)(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.

PLR-103694-19 3

    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 part, 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 submitted and the representations made, we conclude

that X's S corporation election terminated on Date 2, because of the inadvertent failure
to timely file ESBT elections with respect to the Trusts, and that this termination of X's S
election was an inadvertent termination within the meaning of § 1362(f). Accordingly,
pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation from Date 2 and thereafter, provided that X's S corporation election was not
otherwise terminated under § 1362(d).

    This ruling is contingent upon the respective trustees of the Trusts filing elections

to treat the Trusts as ESBTs, effective Date 2, with the appropriate service center within
120 days of the date of this letter. A copy of this letter should be attached to each of the

PLR-103694-19 4

three ESBT elections. X and its shareholders must also file any necessary original or
amended returns consistent with the relief granted in this letter within 120 days of this
letter. If X or its shareholders fail to treat X as described above, this letter ruling will be
null and void. Furthermore, if these conditions are not met, X must send notification that
its S election has terminated to the service center to which X’s election was filed.

    Except as specifically set forth above, no opinion is expressed or implied

concerning the federal tax consequences of any transaction or item discussed or
referenced in this letter. Specifically, we express or imply no opinion on whether X is
otherwise eligible to be an S corporation described in § 1361, or whether the Trusts are
eligible to be ESBTs within the meaning of § 1361(e).

   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.

    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 representatives.

                                    Sincerely,

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

Enclosures: 2
Copy of this letter
Copy for § 6110 purposes