S corporation status restored after trustees missed the ESBT elections following a shareholder's death

Plain-English summary

An S corporation can only have certain kinds of shareholders. A trust can hold S
corporation stock if it makes an "electing small business trust" (ESBT) election;
without that election, the trust is an ineligible shareholder and the company's S
status ends automatically. Here a married couple had donated shares to five joint
trusts. When the wife died, each trust split into two, and the trustees failed to
file the required ESBT elections for the new trusts. That made them ineligible
shareholders and terminated the company's S election. The company represented the
lapse was inadvertent, not tax-motivated, and that it had always filed as an S
corporation. The IRS agreed the termination was inadvertent under Section 1362(f)
and ruled the company would continue to be treated as an S corporation, provided
it and its shareholders make any adjustments the IRS requires. This is standard
relief that prevents an accidental, costly loss of passthrough tax treatment.

Ruling snapshot

• Question: Was the termination of the company's S election, caused by the
  trustees' failure to make timely ESBT elections, an inadvertent termination
  eligible for relief under Section 1362(f)?
• Outcome: Approved (S corporation status continued; relief granted)
• Key authorities: IRC §§ 1361(b), 1361(c)(2), 1361(e), 1362(f); Treas. Reg.
  §§ 1.1361-1(m), 1.1362-4

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202210014                                              Third Party Communication: None
 Release Date: 3/11/2022                                        Date of Communication: Not Applicable
 Index Number: 1361.00-00, 1361.01-00,
               1361.01-04, 1362.00-00,                          Person To Contact:
               1362.02-00, 1362.04-00                           --------------------, ID No. -----------------
                                                                Telephone Number:
 ---------------------                                          --------------------
 ---------------------------                                    Refer Reply To:
 -----------------------                                        CC:PSI:03
 -------------------------                                      PLR-115330-21
 -----------------------------                                  Date:
                                                                December 14, 2021




Legend

Company = ----------------------
---------------------------------------------

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

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

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

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

Husband =         -------------------

Wife =            --------------------

a=                -----

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

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

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

Trust 4 =          --------------------------------------------------------
-------------------------------------------
PLR-115330-21                                             2


Trust 5 =          -----------------------------------------------------------
-------------------------------------------




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

      This letter responds to a letter dated July 26, 2021, and subsequent
correspondence, submitted on behalf of Company by its authorized representative,
requesting a ruling under § 1362(f) of the Internal Revenue Code (Code).

                                                       Facts

        The information submitted states Company was organized on Date 1, as a
corporation under the laws of State. After formation Company elected to be taxed as an
S corporation. On Date 2, Husband and Wife jointly donated a% of shares of Company
to five joint trusts.

       On Date 3, under the provisions of the trust instrument creating the trusts, after
the death of Wife each of the five trusts automatically divided each into two separate
trusts. Company represents that five of the newly formed Trusts (Trust 1, Trust 2, Trust
3, Trust 4 and Trust 5), have at all times met all of the requirements to qualify as
Electing Small Business Trusts (ESBTs) except for trustee's failure to file timely such
elections under section 1361(e)(3). Consequently, Trusts were ineligible shareholders,
and, as a result, Company's S corporation election terminated on Date 3. Company
also represents that the remaining trust shareholders were eligible S corporation
shareholders.

       Company represents that upon discovering that its S election had terminated,
Company took corrective action by filing this request for relief. Company represents
that the circumstances resulting in the inadvertent termination and the failure to make
timely ESBT elections was inadvertent and not motivated by tax avoidance or
retroactive tax planning. Company further represents that it has filed its income tax
returns consistent with having a valid S election in effect for all taxable years since
Company elected to be an S corporation. Lastly, Company and its shareholders agree
to make any adjustments required as a condition of obtaining relief under § 1362(f) that
may be required by the Secretary.


                                               Law and Analysis
PLR-115330-21                                 3

       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
one class of stock.

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

         Section 1361(e)(1)(A) 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)(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 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) of the Income Tax Regulations provides, in relevant
part, 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 1362(a)(1) provides that except as provided in § 1362(g), a small
business corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

       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 to obtain shareholder consents, (2) the Secretary determines that the
circumstances resulting in such ineffectiveness were inadvertent; (3) no later than a
reasonable period of time after discovery of the circumstances resulting in such
ineffectiveness, steps were taken so that the corporation for which the election was
made is a small business corporation; and (4) the corporation for which the election was
made, 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
PLR-115330-21                               4

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, such corporation shall be treated as an S corporation during the
period specified by the Secretary.

      Section 1.1362-4(d) of the Income Tax Regulations provides that the
Commissioner may require any adjustments that are appropriate. In general, the
adjustments required 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 the representations made, we conclude
that Company's S corporation election was not effective on Date 3, when the trustees of
Trusts failed to file ESBT elections under § 1361(e)(3). We further conclude that the
ineffectiveness of Company's S election was inadvertent within the meaning of
§ 1362(f). Therefore, under § 1362(f), Company will be treated as an S corporation on
and after Date 3, provided Company's S corporation election was otherwise valid and
not otherwise terminated under § 1362(d).

       This ruling is contingent upon Company and each of its shareholders filing any
amended returns and making such adjustments that are necessary to properly reflect
the reporting of Company's items of S corporation income.

        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
Company's eligibility to be an S corporation or whether the Trusts were or are otherwise
eligible to be an ESBT.

      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.

       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-115330-21                                 5


        Pursuant to the power of attorney on file with this office, we are sending a copy of
this letter to Company's authorized representative.

                                      Sincerely,



                                      Richard T. Probst
                                      Senior Technician Reviewer, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)
Enclosures (2):
      Copy of this letter
      Copy for 6110 purposes



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