S corporation received relief after a trust missed its ESBT election

Plain-English summary

An S corporation's ownership interests were transferred to a trust whose trustees did not timely elect to treat it as an electing small business trust (ESBT). Because a trust must qualify as an eligible S corporation shareholder, the missed ESBT election terminated the corporation's S election. The trust otherwise met the ESBT requirements, the corporation had continued filing as an S corporation, and the affected parties agreed to required adjustments. The IRS treated the termination as inadvertent and allowed continuous S corporation status. Relief was conditioned on the trustees filing the ESBT election within 120 days, the trust filing any necessary amended returns and adjustments, and a specified payment being sent by the redacted deadline.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after its shareholder trust failed to make a timely ESBT election?
• Outcome: approved (continuous S corporation treatment, subject to filing, payment, and adjustment conditions)
• Key authorities: IRC §§ 1361(c)(2), 1361(e), 1362(d)(2), 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: 202251004                                            Third Party Communication: None
 Release Date: 12/23/2022                                     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:03
                                                              PLR-106456-22
                                                              Date:
                                                              September 26, 2022




LEGEND

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

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

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

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

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

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

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

 $n             = ---------------



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

      This letter responds to a letter dated March 3, 2022, and subsequent
correspondence, submitted on behalf of Company by its authorized representative,
requesting a ruling under § 1362(f) of the Internal Revenue Code (Code).
PLR-106456-22                                 2

                                          FACTS

       According to the information submitted and representations made, Company,
organized under the laws of State, made an election to be treated as an S corporation
on Date 1, effective as of Date 2. On Date 3, membership interests in Company were
transferred to Trust. However, the trustees of Trust did not make a timely election for
Trust to be treated as an electing small business trust (ESBT) under § 1361(e)(3), thus
causing Company’s S election to terminate effective Date 3.

        Company represents that Trust has at all times met the requirements of an ESBT
within the meaning of § 1361(e), except that the trustees of Trust did not make a timely
ESBT election under § 1361(e)(3). Company represents that Trust will file to elect to be
treated as an ESBT under § 1361(e)(3) if a ruling request is granted. Company further
represents that it has filed income tax returns consistent with having a valid S election in
effect for all taxable years since its election on Date 1. Company and Company’s
shareholders from Date 3 and thereafter consent to make any adjustments consistent
with the treatment of Company as an S corporation as may be required by the
Commissioner.

                                  LAW AND ANALYSIS

        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 that is not an ineligible corporation and 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 § 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)(1)(B) provides that an ESBT does 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
PLR-106456-22                                 3

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) of the Income Tax Regulations 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 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. A termination of an S corporation election under § 1362(d)(2) shall be
effective on and after the date of cessation.

        Section 1362(f) provides that if (1) an election under § 1362(a) by any
corporation was terminated under § 1362(d)(2) or (3); (2) the Secretary determines that
the circumstances resulting in termination were inadvertent; (3) no later than a
reasonable period of time after discovery of the circumstances resulting in termination,
steps were taken so that the corporation is a small business corporation, 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 the adjustments
(consistent with the treatment of the corporation as an S corporation) as might be
required by the Secretary regarding this period, then, notwithstanding the circumstances
resulting in termination, the 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 Company’s S corporation election terminated on Date 3 when the trustees of Trust
failed to make elections under section § 1362(e)(3) to treat Trust as an ESBT effective
Date 3. We further conclude that the termination of Company’s S election was
inadvertent within the meaning of § 1362(f). Therefore, pursuant to the provisions of
§ 1362(f), Company will be treated as an S corporation effective Date 3 and thereafter,
PLR-106456-22                                 4

provided Company’s S corporation election is otherwise valid and not otherwise
terminated under § 1362(d).

       This letter is contingent on the following: within 120 days of this letter (1) the
trustees of Trust filing an election to treat Trust as an ESBT, effective Date 3, with the
appropriate service center, and (2) Trust filing any amended returns and making
adjustments to properly reflect the treatment of the trusts as ESBTs for all taxable
years. A copy of this letter should be attached to any elections or returns.

        Furthermore, as an adjustment under § 1362(f)(4), a payment of $n and a copy
of this letter must be sent to the following address:

                                   Internal Revenue Service
                                   Kansas City Service Center
                                   333 W. Pershing Road
                                   Kansas City, MO 64108
                                   Stop 7777
                                   Attn: Manual Deposit

       This payment and a copy of this letter must be sent no later than Date 4.

       If the conditions are not met, this ruling is null and void. In addition, if these
conditions are not met, Company must notify the service center with which it filed its S
corporation election that its election terminated on Date 3.

       Except as specifically set forth above, we express or imply no opinion concerning
the federal tax consequences of the facts described above under any other provision of
the Code. Specifically, we express or imply no opinion regarding Company's eligibility
to be an S corporation or Trust's eligibility to elect to be treated as an ESBT.

      The ruling contained in this letter are 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 request for rulings, 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.
PLR-106456-22                               5

      In accordance with the Power of Attorney on file with this office, we are sending a
copy of this letter to Company’s authorized representatives.

                                     Sincerely,


                                     /S/
                                     Richard T. Probst
                                     Senior Technician Reviewer, Branch 3
                                     Office of Associate Chief Counsel
                                     (Passthroughs & Special Industries)



Enclosure:
      Copy of this letter for § 6110 purposes




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