S corporation gets inadvertent-termination relief after eleven trusts missed their ESBT elections

Plain-English summary

An S corporation's special tax status can terminate automatically if its stock is
held by an ineligible shareholder. A trust can hold S corporation stock only if it
qualifies as an Electing Small Business Trust (ESBT) and its trustee files the ESBT
election on time. Here, eleven trusts acquired stock in the company over several
dates, and each trustee failed to file the required ESBT election, which
terminated the company's S corporation status as of the first such date. The
company asked the IRS to treat the terminations as inadvertent under IRC § 1362(f).
Because the lapses were not motivated by tax avoidance and everyone had filed
returns as if the elections were valid, the IRS granted relief: the company is
treated as continuing to be an S corporation, and the trusts are treated as ESBTs,
provided the trustees file the missing ESBT elections and any needed returns
within 120 days. This spares the company and its shareholders from being taxed as
a regular C corporation for the intervening years.

Ruling snapshot

• Question: Was the termination of the company's S corporation status (caused by trusts failing to file ESBT elections) inadvertent, qualifying for relief under § 1362(f)?
• Outcome: Approved (inadvertent-termination relief granted, subject to 120-day conditions)
• Key authorities: IRC § 1362(f); IRC §§ 1361(b), 1361(c)(2), 1361(e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 202234003                                               Third Party Communication: None
Release Date: 8/26/2022                                         Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.04-00
                                                                Person To Contact:
------------------------------------------------                ------------------------, ID No. -----------------
---------------------------------------                         Telephone Number:
--------------------------------                                --------------------
------------------------                                        Refer Reply To:
--------------------------------------------------------        CC:PSI:B01
                                                                PLR-124294-21
                                                                Date:
                                                                May 27, 2022




                                                  LEGEND

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

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

Year 1        =       -------

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

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

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

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

Date 5        =       -----------------------

Date 6        =       -----------------------

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

Trust 2       =       --------------------------------------------------------------
                      -------------------------
PLR-124294-21                                            2


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

 Trust 4      =        --------------------------------------------------------------
                       ------------------------

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

 Trust 6      =        --------------------------------------------------------------
                       -------------------------

 Trust 7      =        ----------------------------------------------------------------
                       -------------------------

 Trust 8      =        --------------------------------------------------------------
                       -------------------------

 Trust 9      =        -----------------------------------------------------------------------------------------------
                       -------------------------

 Trust 10     =        -------------------------------------------------------------------------------
                       -------------------------

 Trust 11     =        -----------------------------------------------------------------
                       -------------------------

 Year         =        -------


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

This responds to a letter dated November 29, 2021, and subsequent correspondence,
submitted on behalf of X by its authorized representatives, requesting a ruling under
§ 1362(f) of the Internal Revenue Code (the Code).

                                                    FACTS

The information submitted states that X was incorporated under the laws of State in
Year 1. X filed an election in accordance with provisions of § 1362(a) of the Code to be
taxed as an S corporation effective Date 1.

On Date 2, Trust 1, Trust 2, and Trust 3 each acquired shares of X stock. X represents
that Trust 1, Trust 2, and Trust 3 each met the requirements of an Electing Small
PLR-124294-21                                3

Business Trust (ESBT) within the meaning of § 1361(e)(1)(A), except that the trustees
of Trust 1, Trust 2, and Trust 3 failed to file an election under § 1361(e)(3) for each
respective trust to be an ESBT effective Date 2. Consequently, Trust 1, Trust 2, and
Trust 3 were ineligible shareholders of X and X's S corporation status was terminated
on Date 2. Nevertheless, X represents that Trust 1, Trust 2, and Trust 3 have each filed
federal income tax returns consistent with having a valid ESBT election in effect during
all relevant taxable years.

On Date 3, Trust 4 and Trust 5 each acquired shares of X stock. X represents that Trust
4 and Trust 5 each met the requirements of an ESBT within the meaning of
§ 1361(e)(1)(A), except that the trustees of Trust 4 and Trust 5 failed to file an election
under § 1361(e)(3) for each respective trust to be an ESBT effective Date 3.
Consequently, Trust 4 and Trust 5 were ineligible shareholders of X and X's S
corporation status would have terminated on Date 3, had it not already terminated on
Date 2. Nevertheless, X represents that Trust 4 and Trust 5 have each filed federal
income tax returns consistent with having a valid ESBT election in effect during all
relevant taxable years.

On Date 4, Trust 6 and Trust 7 each acquired shares of X stock. X represents that Trust
6 and Trust 7 each met the requirements of an ESBT within the meaning
§ 1361(e)(1)(A), except that the trustees of Trust 6 and Trust 7 failed to file an election
under § 1361(e)(3) for each respective trust to be an ESBT effective Date 4.
Consequently, Trust 6 and Trust 7 were ineligible shareholders of X and X's S
corporation status would have terminated on Date 4, had it not already terminated on
Date 2. Nevertheless, X represents that Trust 6 and Trust 7 have each filed federal
income tax returns consistent with having a valid ESBT election in effect during all
relevant taxable years.

On Date 5, Trust 8 acquired shares of X stock. X represents that Trust 8 met the
requirements of an ESBT under § 1361(e)(1)(A), except that the trustee of Trust 8 failed
to file an election under § 1361(e)(3) for Trust 8 to be an ESBT effective Date 5.
Consequently, Trust 8 was an ineligible shareholder of X and X's S corporation status
would have terminated on Date 5, had it not already terminated on Date 2.

On Date 6, Trust 9, Trust 10, and Trust 11 each acquired shares of X stock. X
represents that Trust 9, Trust 10, and Trust 11 each met the requirements of an ESBT
within the meaning of § 1361(e)(1)(A), except that the trustees of Trust 9, Trust 10, and
Trust 11 failed to file an election under § 1361(e)(3) for each respective trust to be an
ESBT effective Date 6. Consequently, Trust 9, Trust 10, and Trust 11 were ineligible
shareholders of X and X's S corporation status would have terminated on Date 6, had it
not already terminated on Date 2. Nevertheless, X represents that Trust 9, Trust 10, and
Trust 11 have each filed federal income tax returns consistent with having an ESBT
election in effect during all relevant taxable years.
PLR-124294-21                                 4

X represents that the circumstances resulting in the termination of X's S corporation
election were not motived by tax avoidance or retroactive tax planning considerations. X
further represents that for each taxable year since X elected to be an S corporation, X
and its shareholders have filed their federal income tax returns consistent with having a
valid S corporation election in effect for X. Further, X and its shareholders have agreed
to make any adjustments consistent with the treatment of X as an S corporation as may
be required by the Secretary with respect to the period specified by § 1362(f).

                                            LAW

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 § 1361(b)(1)(B), an ESBT is a
permitted shareholder of a small business corporation.

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 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 16-day-and-2-month period
beginning on the day that the stock is transferred to the trust).
PLR-124294-21                                5

Section 1362(d)(2) provides that (A) in general, an election under § 1362(a) shall 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, and (B) any termination under § 1362(d)(2) shall be effective on
and after the date of cessation.

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 information submitted and the representations made, we conclude
that X's S corporation election terminated on Date 2 when Trust 1, Trust 2, and Trust 3
became ineligible shareholders. We also conclude that X’s S corporation election would
have terminated on Date 3 when Trust 4 and Trust 5 became ineligible shareholders,
had it not already terminated on Date 2. Additionally, we conclude that X's S corporation
election would have terminated on Date 4 when Trust 6 and Trust 7 became ineligible
shareholders, had it not already terminated on Date 2. Additionally, we conclude that X's
S corporation election would have terminated on Date 5 when Trust 8 became an
ineligible shareholder, had it not already terminated on Date 2. Additionally, we
conclude that X's S corporation election would have terminated on Date 6 when Trust 9,
Trust 10, and Trust 11 became ineligible shareholders, had it not already terminated on
Date 2.

We further conclude that the circumstances resulting in the termination of X's S
corporation election were inadvertent 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
valid and was not otherwise terminated under § 1362(d) for reasons not addressed in
this letter.
PLR-124294-21                                  6

Trust 1, Trust 2, Trust 3, Trust 4, Trust 5, Trust 6, Trust 7, Trust 8, Trust 9, Trust 10, and
Trust 11 will each be treated as an ESBT from the date each trust acquired shares of X
stock (as described in this letter) and thereafter. This letter is subject to the following
conditions that must occur within 120 days from the date of this letter: (1) the trustees of
Trust 1, Trust 2, and Trust 3 must each file an election to treat Trust 1, Trust 2, and
Trust 3 as an ESBT effective Date 2 with the appropriate service center; (2) the trustees
of Trust 4 and Trust 5 must each file an election to treat Trust 4 and Trust 5 as an ESBT
effective Date 3 with the appropriate service center; (3) the trustees of Trust 6 and Trust
7 must each file an election to treat Trust 6 and Trust 7 as an ESBT effective Date 4
with the appropriate service center; (4) the trustee of Trust 8 must file an election to
treat Trust 8 as an ESBT effective Date 5 with the appropriate service center; (5) the
trustees of Trust 9, Trust 10, and Trust 11 must each file an election to treat Trust 9,
Trust 10, and Trust 11 as an ESBT effective Date 6 with the appropriate service center;
and (6) X and each of its shareholders must file any necessary original or amended
returns for Year and all subsequent taxable years consistent with the relief granted in
this letter.

A copy of this letter should be attached to each ESBT election. Furthermore, if these
conditions are not met, X must notify the service center where X's S corporation
election is filed that its S corporation election has terminated effective Date 2.

Except as specifically set forth above, we express or imply no opinion concerning the
federal tax consequences of the transactions described above under any other
provision of the Code. Specifically, we express or imply no opinion regarding X's
eligibility to be an S corporation or the eligibility of Trust 1, Trust 2, Trust 3, Trust 4,
Trust 5, Trust 6, Trust 7, Trust 8, Trust 9, Trust 10, or Trust 11 to be an ESBT.

The ruling contained in this letter is based on 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-124294-21                                 7

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,


                                          /s/ Jennifer Keeney

                                          Jennifer N. Keeney
                                           Senior Counsel, Branch 1
                                           Office of the Associate Chief Counsel
                                           (Passthroughs & Special Industries)


Enclosure
      Copy for § 6110 purposes



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