S corporation receives relief for late ESBT elections

Plain-English summary

Two trusts acquired shares in an S corporation but their trustees did not timely elect electing small business trust status, causing the corporation's S election to terminate. The corporation represented that the missed elections were inadvertent, were not motivated by tax avoidance or retroactive tax planning, and had not changed how the corporation or trusts filed their returns. The IRS granted relief under section 1362(f) and treated the corporation as continuing to be an S corporation from the first acquisition date. Relief was conditioned on both trustees filing ESBT elections effective as of that date within 120 days of the ruling. The IRS did not rule on whether the corporation otherwise qualified as an S corporation or whether the trusts otherwise qualified as ESBTs.

Ruling snapshot

• Question: Could the corporation receive inadvertent-termination relief after two shareholder trusts missed their ESBT elections?
• Outcome: Approved, subject to timely corrective ESBT elections
• Key authorities: IRC §§ 1361 and 1362(f); Treas. Reg. § 1.1361-1(m)(2)(iii)

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202323008                                              Third Party Communication: None
 Release Date: 6/9/2023                                         Date of Communication: Not Applicable
 Index Number: 1361.03-03, 1362.00-00,
               1362.04-00                                       Person To Contact:
                                                                --------------------------, ID No. ----------------
 -------------------------                                      -----------------
 ---------------------------------------------------            Telephone Number:
 -----------------------------                                  --------------------
 -------------------------------                                Refer Reply To:
 ------------------------------------                           CC:PSI:B01
                                                                PLR-118030-22
                                                                Date:
                                                                March 15, 2023




                                                       LEGEND

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

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

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

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

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

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

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


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

        This responds to a letter dated September 21, 2022, and subsequent
correspondence, submitted on behalf of X by X’s authorized representative, requesting
relief under section 1362(f) of the Internal Revenue Code (the Code).

                                                       FACTS

       The information submitted states that X was formed on Date 1 under the laws of
State and elected to be treated as an S corporation as of formation.
PLR-118030-22                                 2


       Trust 1 and Trust 2 acquired shares in X on Date 2, and acquired additional
shares in X on Date 3. X represents that Trust 1 and Trust 2 qualified to elect to be
treated as Electing Small Business Trusts (ESBTs) as of Date 2 and Date 3. However,
the trustees of Trust 1 and Trust 2 failed to make timely ESBT elections under
§ 1361(e)(3), thereby causing X’s S corporation election to terminate on Date 2.

       X represents that the circumstances resulting in the failure to file an ESBT
election for Trust 1 and Trust 2 were inadvertent and not motivated by tax avoidance or
retroactive tax planning. X also represents that it has filed income tax returns consistent
with having a valid S corporation election in effect for all taxable years since its election
to be an S corporation, and that Trust 1 and Trust 2 have filed income tax returns
consistent with having an ESBT election in effect for all relevant years. X further
represents that X and its shareholders agree to make any adjustments required by the
Secretary as a condition of obtaining relief as provided under § 1362(f).

                                   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) 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 1
class of stock.

       Section 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an
electing small business trust (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 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)).
PLR-118030-22                                  3

       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)(iii) of the Income Tax Regulations 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 S corporation election will 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.

        Section 1362(f) provides, in relevant part, 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 such termination were inadvertent; (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
such 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 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 representations made, we conclude that
X’s S corporation election terminated on Date 2 when the trustees of Trust 1 and Trust 2
failed to file ESBT elections under § 1361(e)(3). In addition, had X’s S corporation
election not terminated on Date 2, it would have terminated on Date 3 when Trust 1 and
Trust 2 acquired additional interests in X. We further conclude that the circumstances
resulting in the termination of X’s S corporation election were inadvertent within the
meaning of § 1362(f). Therefore, pursuant to the provisions of § 1362(f), X will be
treated as continuing to be an S corporation from Date 2 and thereafter, provided X’s S
corporation election was otherwise valid and not otherwise terminated under § 1362(d)
for reasons not addressed in this letter.

        This letter ruling is contingent on the trustees of Trust 1 and Trust 2 filing within
120 days from the date of this letter ESBT elections on behalf of Trust 1 and Trust 2
effective Date 2 with the appropriate service center. A copy of this letter should be
PLR-118030-22                                  4

attached to each ESBT election. If this condition is not met, then this letter ruling is null
and void.

         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 X’s
eligibility to be an S corporation or Trust 1 or Trust 2’s eligibility to be ESBTs.

      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.

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

                                           Sincerely,


                                           _/s/__________________________
                                           Caroline E. Hay
                                           Senior Technician Reviewer, Branch 1
                                           Office of the Associate Chief Counsel
                                           (Passthroughs & Special Industries)


Enclosures
      Copy of this letter for Section 6110 purposes




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