Missing ESBT election does not invalidate corporation's S status

Plain-English summary

A trust held stock when a corporation's S election was supposed to take effect, but the trustee had not elected electing small business trust treatment. The trust therefore was not an eligible S corporation shareholder, making the corporation's S election ineffective. The corporation and shareholders consistently filed as though S status applied, the trust filed consistently with ESBT treatment, and the omission was not motivated by tax avoidance or retroactive planning. The IRS treated the failed S election as inadvertent and allowed S status from the intended date, conditioned on the trust filing an ESBT election within 120 days.

Ruling snapshot

• Question: Can an S election remain effective when a shareholder trust inadvertently fails to make a timely ESBT election?
• Outcome: approved, conditioned on filing the ESBT election within 120 days
• Key authorities: IRC §§ 1361(c)(2) and (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: 202005002 Third Party Communication: None
Release Date: 1/31/2020 Date of Communication: Not Applicable
Index Number: 1362.01-00
Person To Contact:
-------------------------------- ------------------------------,
---------------------------- ID No. ----------------
---------------------------------------- Telephone Number:
---------------------------------- ----------------------
Refer Reply To:
CC:PSI:B01
PLR-103703-19
Date:
August 30, 2019

LEGEND

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

Trust = ------------------------------------------

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

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

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

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

   This responds to a letter dated February 19, 2019, and supplemental information,

submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code (the Code).

Facts

    According to the information submitted and representations within, X was

incorporated under the laws of State on Date 1 and elected to be an S corporation
effective Date 2. Trust was a shareholder of X on Date 2, but Trust was an invalid S
corporation shareholder. Therefore, X’s S corporation election on Date 2 was invalid. X
represents that Trust qualified to elect to be treated as an electing small business trust
(ESBT) under § 1361(e) but an ESBT election was not made.

   X represents that X and its shareholders have treated X as an S corporation at all

relevant times. X further represents that Trust has filed its income tax returns consistent
with being an ESBT. X represents that the failure to file a valid ESBT election for Trust

PLR-103703-19 2

was inadvertent and was not motivated by tax avoidance or retroactive tax planning.
Further, X represents that X and its shareholders agree to make any adjustments
(consistent with the treatment of X as an S corporation) that may be required by the
Secretary.

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) defines a “small business corporation” as a domestic

corporation which is not an ineligible corporation and which does not (A) have more
than 100 shareholders, (B) 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, (C) have a nonresident alien as a shareholder, and (D) have more than 1
class of stock.

   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.

    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

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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(f) provides, in relevant part, that if (1) an election under § 1362(a)

by any corporation 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 was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that
the circumstances resulting in such ineffectiveness or termination were inadvertent; (3)
no later than a reasonable period of time after discovery of the circumstances resulting
in such ineffectiveness or termination, steps were taken so that the corporation for
which the election was made or termination occurred is a small business corporation;
and (4) the corporation for which the election was made or 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 the 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
ineffectiveness or 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 the representations made, we conclude

that X’s S corporation election was not effective on Date 2 because Trust was not an
eligible shareholder of X. We further conclude that X’s ineffective S election on Date 2
was inadvertent within the meaning of § 1362(f). Therefore, X will be treated as an S
corporation effective Date 2 and thereafter, provided that X’s S corporation election is
otherwise valid and not otherwise terminated under § 1362(d).

    This letter ruling is subject to the condition that within 120 days from the date of

this letter an election to treat Trust as an ESBT effective Date 2 must be made with the
appropriate service center. A copy of this letter should be attached to the ESBT
election. If this condition is not met, then this ruling is null and void. Furthermore, if this
condition is not met, X must send notification that its S election has terminated to the
service center with which its S election was filed.

     Except as specifically ruled upon above, we express or imply no opinion

concerning the federal tax consequences of the facts of this case under any other
provision of the Code. Specifically, we express or imply no opinion regarding X’s
eligibility to be an S corporation.

   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-103703-19 4

  This ruling is directed only to the taxpayer who requested it. According to §

6110(k)(3), this ruling may not be used or cited as precedent.

    Pursuant to the power of attorney on file with this office, we are sending a copy of

this letter to your authorized representatives.

                                      Sincerely,


                                      Joy C. Spies
                                      Joy C. Spies
                                      Senior Technician Reviewer, Branch 1
                                      Office of Associate Chief Counsel
                                      (Passthroughs & Special Industries)

Enclosures (2)

   Copy of this letter
   Copy of this letter for section 6110 purposes

cc: