Missing ESBT elections do not invalidate S corporation status

Plain-English summary

A corporation filed an S corporation election while five trusts held its stock. The trusts qualified in substance as electing small business trusts, but their trustees did not timely file the required ESBT elections. That omission made the corporation's S election invalid from its intended effective date. The corporation and shareholders had consistently filed as though the corporation were an S corporation and the trusts were ESBTs, and they agreed to make any required adjustments. The IRS found the invalidity inadvertent and ruled that the corporation would be treated as an S corporation from the original effective date forward, provided its election was not otherwise terminated. The ruling did not independently confirm that the corporation qualified as an S corporation or that the trusts qualified as ESBTs.

Ruling snapshot

• Question: Can the corporation retain S corporation treatment despite five trusts' untimely ESBT elections?
• Outcome: Approved as inadvertent-election relief
• Key authorities: IRC §§ 1361(e) 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: 202326004                                              Third Party Communication: None
 Release Date: 6/30/2023                                        Date of Communication: Not Applicable
 Index Numbers: 1362.00-00, 1362.04-00
                                                                Person To Contact:
 -----------------------------------                            -------------------, ID No. -----------------
 ------------------------------------------------------         Telephone Number:
 ---------------------                                          --------------------
 ----------------------------------                             Refer Reply To:
 ----------------------------                                   CC:PSI:03

                                                                PLR-117369-22
                                                                Date:
                                                                March 13, 2023

Legend:

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

State             =        ---------

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

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

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

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

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

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


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

        This letter responds to a letter dated August 30, 2022, and subsequent
correspondence submitted on behalf of X by its authorized representatives, requesting
relief under § 1362(f) of the Internal Revenue Code (Code).
PLR-117369-22                                 2


                                           Facts

      According to the information submitted and representations made, X was
incorporated under the laws of State. Effective Date 1, X filed an election to be taxed as
an S corporation.

       Trust 1, Trust 2, Trust 3, Trust 4, and Trust 5 (collectively “the Trusts”) were all
shareholders of X on Date 1. However, timely elections to treat the Trusts as Electing
Small Business Trusts (ESBTs) were not made, causing X's S corporation election on
Date 1 to be invalid. X represents that the Trusts have at all times met the requirements
of 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 the invalidity of its 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 the Trusts as 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.

        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
PLR-117369-22                                 3


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 terminated under § 1362(d)(2); (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 the representations made, we conclude
that X's S corporation election on Date 1 was invalid because the Trusts were not
eligible shareholders. We also conclude that the invalidity 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 being an S corporation from Date 1 and
thereafter, provided that X's S corporation election was not otherwise terminated under
§ 1362(d).

       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
PLR-117369-22                                  4


Code and the regulations thereunder. Specifically, we express or imply no opinion
regarding X's eligibility to be an S corporation or the Trusts’ eligibility to be ESBTs.

       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.

        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,



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



Enclosure:
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