Late ESBT election receives inadvertent S corporation termination relief

Plain-English summary

A trust owning stock in an S corporation ceased to be a grantor trust and qualified to become an electing small business trust, but its trustee did not timely file the ESBT election. That omission caused the corporation's S election to terminate because the trust was no longer an eligible shareholder. The corporation and its shareholders continued filing consistently with S status and represented that the mistake was inadvertent and unrelated to tax avoidance. The IRS granted relief under section 1362(f), allowing the corporation to continue as an S corporation. The ruling was conditioned on the trustee filing a retroactive ESBT election within 120 days.

Ruling snapshot

• Question: May the corporation retain S status after its shareholder trust failed to timely elect ESBT treatment?
• Outcome: approved
• Key authorities: IRC §§ 1361(c), 1361(e), 1362(d), and 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202009022                                              Third Party Communication: None
Release Date: 2/28/2020                                        Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.01-02,
              1361.03-00, 1361.03-03,                          Person To Contact:
              1362.00-00, 1362.04-00                           ---------------------, ID No. ---------------
                                                               Telephone Number:
-------------------------------------------------              --------------------
--------------------------------------                         Refer Reply To:
------------------                                             CC:PSI:B03
--------------------------------                               PLR-116913-19
                                                               Date:
                                                               November 25, 2019
LEGEND

X:            ----------------------------------------
------------------------------------

Trust:        ----------------------------------------------
--------------------
------------------------------------

A:          ---------------------

D1:          -----------------

D2:          -----------------

D3:         ----------------------

D4:          --------------------------

D5:          -------------------

State:      ----------

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

      This letter responds to a letter dated July 16, 2019, submitted on behalf of X,
requesting a ruling under § 1362(f) of the Internal Revenue Code (the Code).

                                                     FACTS

       According to the information submitted and representations made, X was formed
on D1 as a corporation under the laws of State. Effective D2, X elected to be treated as
an S corporation. Prior to D3, Trust, a shareholder of X, was a grantor trust that was
treated (under subpart E, part I of subchapter J of chapter 1) as owned by A. On D3,
the terms of Trust were modified such that Trust ceased to be a grantor trust.
PLR-116913-19                                 2


       X represents that as of D3, Trust satisfied the Electing Small Business Trust
(ESBT) requirements within the meaning of § 1361(e), but that the trustee of Trust failed
to make an election under section 1361(e)(3) of the Code. Therefore, X’s S corporation
election terminated on D3.

        X and the trustee of Trust represent that Trust does not have a power described
in § 1.1361-1(m)(4)(vi)(B). X also represents that, other than the failure to make valid
an ESBT election on D3, X qualified as a small business corporation at all times since
its election on D2. X represents that X and its shareholders treated X as an S
corporation. X filed its income tax returns consistent with having a valid S election in
effect for all taxable years since D2 and that Trust filed its tax returns as an ESBT for
the period from D4 through D5.

        X further represents that its S corporation election termination was inadvertent
and not motivated by tax avoidance or retroactive tax planning. X represents that X and
its shareholders agree to make any adjustments required as a condition of obtaining
relief under the inadvertent termination rule as provided under § 1362(f) that may be
required by the Secretary.

                                            LAW

        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) provides that the term “small business corporation” means 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 one class of stock.

     Section 1361(c)(2)(A)(v) provides that for purposes of section 1361(b)(1)(B), an
ESBT may be a permissible S corporation shareholder.

        Section 1361(e)(1)(A) provides that 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 paragraph (2), (3), (4), or
(5) of § 170(c), 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.
PLR-116913-19                                 3

        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
qualified subchapter S trust election (generally within the 15-day-and-2-month period
beginning on the day that the stock is transferred to the trust).

       Section 1362(d)(2)(A) 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(d)(2)(B) provides that any termination under
§ 1362(d)(2)(A) is effective on and after the date of cessation.

       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), (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 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 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 the failure of Trust to file an ESBT election effective D3 caused an inadvertent
PLR-116913-19                                  4

termination of X’s S corporation election within the meaning of § 1362(f) on D3.
Pursuant to the provisions of § 1362(f), X will be treated as continuing to be an S
corporation beginning on and after D3, unless X’s S corporation election is otherwise
terminated under § 1362(d).

       This letter ruling is contingent upon the filing of an ESBT election within one
hundred-twenty (120) days from the date of this letter effective D3 for Trust 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 X’s S election was filed.

       Except for the specific ruling 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.

       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 the 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 requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

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


                                        Sincerely,



                                        Adrienne M. Mikolashek
                                        Branch Chief, Branch 3
                                        (Passthroughs & Special Industries)

Enclosures (2):

Copy of this letter
Copy of this letter for § 6110 purposes


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