S corporation status restored after four trusts forgot to file their ESBT elections

Plain-English summary

A company had elected to be taxed as an S corporation, a pass-through structure
that limits who may own the stock. Four trusts later acquired shares. Each trust
could have qualified as an eligible owner, called an Electing Small Business
Trust (ESBT), but the trustees never filed the required ESBT elections. That
made the trusts ineligible shareholders and automatically terminated the
company's S corporation status. Everyone involved had kept filing tax returns as
though the S election and the ESBT status were valid. The company asked the IRS
to treat the termination as inadvertent under section 1362(f). The IRS agreed,
finding the lapse was not driven by tax avoidance, and ruled that the company
will be treated as remaining an S corporation without interruption. The relief is
conditional: within 120 days the four trusts must file their ESBT elections
effective back to the acquisition date, and the company and its shareholders must
file any returns needed to line up with the relief.

Ruling snapshot

• Question: Was the termination of the company's S corporation election, caused by four trusts failing to file ESBT elections, inadvertent under section 1362(f)?
• Outcome: Approved (inadvertent termination relief granted, subject to 120-day conditions)
• Key authorities: IRC § 1362(f); IRC § 1361(e) (ESBT election); IRC § 1361(c)(2)

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202329002                                             Third Party Communication: None
 Release Date: 7/21/2023                                       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:01
                                                               PLR-120378-22
                                                               Date:
                                                               April 21, 2023




                                                      LEGEND

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

 State         =     --------

 Date 1        =     ----------------------------------------------------------------------------------------------
                     ----------------------------------------------------------------------------------------------
 Date 2        =     --------------------------------

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

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

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

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

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

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

This responds to a letter dated October 11, 2022, 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).
PLR-120378-22                                 2

                                           FACTS

The information submitted states that X was incorporated under the laws of State on
Date 1. X filed an election in accordance with provisions of § 1362(a) of the Code to be
taxed as an S corporation effective Date 2.

On Date 3, Trust 1, Trust 2, Trust 3 and Trust 4 each acquired shares of X stock. X
represents that Trust 1, Trust 2, Trust 3 and Trust 4 each met the requirements of an
Electing Small Business Trust (ESBT) within the meaning of § 1361(e)(1)(A), except
that the trustees of Trust 1, Trust 2, Trust 3 and Trust 4 failed to file an election under
§ 1361(e)(3) for each respective trust to be an ESBT effective Date 3. Consequently,
Trust 1, Trust 2, Trust 3 and Trust 4 were ineligible shareholders of X and X's S
corporation status was terminated on Date 3. Nevertheless, X represents that Trust 1,
Trust 2, Trust 3 and Trust 4 have each filed federal income tax returns consistent with
having a valid ESBT election in effect during all relevant taxable years.

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.
PLR-120378-22                                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)(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).

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 3 when Trust 1, Trust 2, Trust 3, and
Trust 4 became ineligible shareholders. 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 3 and thereafter, provided that
PLR-120378-22                                    4

X's S corporation election was valid and was not otherwise terminated under § 1362(d)
for reasons not addressed in this letter.

This letter is subject to the following conditions, which must occur within 120 days from
the date of this letter: (1) the trustees of Trust 1, Trust 2, Trust 3, and Trust 4 must each
file an election to treat Trust 1, Trust 2, Trust 3, and Trust 4 as an ESBT effective Date 3
with the appropriate service center; and (2) X and each of its shareholders must file any
necessary original or amended returns for all open 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 3.

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, or Trust 4 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.

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,




                                             Joy C. Spies
                                             Senior Technician Reviewer, Branch 1
                                             Office of the Associate Chief Counsel
                                             (Passthroughs & Special Industries)


Enclosure
      Copy for § 6110 purposes
PLR-120378-22                                           5

cc: --------------------
    ------------------------------------------------------------------
    ----------------------------------------
    --------------------------
    --------------------------------

     -------------------------
     ------------------------------------------------------------------
     ----------------------------------------
     --------------------------
     --------------------------------

     ----------------------------------
     ----------------------------------------------------
     ------------