S corporation status preserved after three trusts missed their ESBT elections

Plain-English summary

An S corporation passes income through to its shareholders untaxed at the corporate level, but only eligible owners may hold the stock. A trust can qualify only if its trustee timely files an Electing Small Business Trust (ESBT) election. Here three trusts acquired shares in the company, and none of the trustees filed a timely ESBT election, which made the company's S corporation election invalid from its effective date. The company represented that the trusts otherwise met every ESBT requirement, that the failure was inadvertent and not tax-motivated, and that everyone had filed as if the company were a valid S corporation. Under Section 1362(f), the IRS can forgive an inadvertent invalid election, and it did, so the company continues as an S corporation from the original date, provided it files a corrected Form 2553 within 120 days. (The letter also notes the company uses a 52-53-week tax year and that the IRS's own acceptance letter had misstated the election's effective date.)

Ruling snapshot

• Question: Was the company's S election, invalidated because three trust shareholders missed their ESBT elections, an inadvertent failure eligible for relief under § 1362(f)?
• Outcome: approved (inadvertent; S status continues, contingent on a corrected Form 2553 within 120 days)
• Key authorities: IRC §§ 1361(b), 1361(c)(2), 1361(e), 1362(a), 1362(d)(2), 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

 Internal Revenue Service                                        Department of the Treasury
                                                                 Washington, DC 20224

 Number: 202308006                                               Third Party Communication: None
 Release Date: 2/24/2023                                         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-111040-22
                                                                 Date:
                                                                 November 18, 2022



Legend

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

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

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

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

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

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

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

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

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

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




Dear ------------------:
PLR-111040-22                                 2

        This letter responds to a letter dated June 6, 2022, and subsequent
correspondence submitted on behalf of X by its authorized representatives, requesting
relief under § 1362(f) of the Internal Revenue Code (Code).

                                           Facts

        According to the information submitted and representations made, X was
incorporated on Date 1, under the laws of State. X elected to be taxed as an S
corporation effective Date 3 because X uses a 52-53-week taxable year. The IRS's
letter acknowledging acceptance of the election, however, misstated the effective date
of the election as Date 4.

       On Date 2, Trust 1, Trust 2, and Trust 3 (together, Trusts) each acquired shares
in X. However, timely elections to treat Trusts as Electing Small Business Trusts
(ESBTs) were not made, causing X's S corporation election to be invalid effective Date

3. Trusts continued to hold the X shares until Date 5, when the shares were transferred
to a permissible shareholder. X represents that Trusts have each, at all times, met the
requirements to qualify as ESBTs within the meaning of § 1361(e), except that the
respective trustees of the Trusts did not make timely ESBT elections under
§ 1361(e)(3).

        X represents that the circumstances resulting in its invalid S corporation election
were not motivated by tax avoidance or retroactive tax planning. Further, X represents
that it and its shareholders have filed tax returns consistent with the treatment of X as
an S corporation and with Trusts being ESBTs. Finally, X and its shareholders agree to
make any adjustments (consistent with the treatment of X as an S corporation) as may
be required by the Secretary.

                                    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 the 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 1 class of stock.

       Section 1361(c)(2)(A)(v) provides that for purposes of § 1361(b)(1)(B), an ESBT
is a permissible shareholder.
PLR-111040-22                                 3

        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 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.

       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 (within the 16-day-and-2-month period beginning
on the day that the stock is transferred to the trust).

      Section 1362(a) provides that a small business corporation may elect to be an S
corporation.

       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(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 by reason of a
failure to meet the requirements of § 1361(b); (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
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.
PLR-111040-22                                 4


                                        Conclusion

        Based solely on the facts submitted and the representations made, we conclude
that X's S corporation election on Date 3 was invalid, because the Trusts were not
eligible S corporation shareholders. We also conclude, however, that the ineffectiveness
of X's S corporation election was 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 3 and thereafter, provided that X's S corporation election
was otherwise valid and was not otherwise terminated under § 1362(d).

       This ruling is contingent on X filing a corrected Form 2553, Election by a Small
Business Corporation, with the appropriate service center, within 120 days from the
date of this letter, effective Date 3. A copy of this letter should be attached to the
election.

       Except as specifically set forth 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 and the regulations thereunder. Specifically, we express or imply no opinion
regarding X's eligibility to be an S corporation or the eligibility of any of Trusts to be an
ESBT.

       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.

      This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of
the Code provides that this ruling may not be used or cited as precedent.
PLR-111040-22                                 5

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


                                      Sincerely,


                                      Associate Chief Counsel
                                      (Passthroughs & Special Industries)


                                          /s/ Margaret Burow
                                  By: _____________________________
                                      Margaret Burow
                                      Senior Counsel, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)



Enclosure
      Copy for § 6110 purposes


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